CIO fears rising over asset prices, China leverage
Ask asset owner chief investment officers (CIOs) in Asia Pacific their chief concerns, and they will likely tell you about their worries over trade wars, and the need to strategise how best to manage rising US interest rates.
But they have other external concerns too, just under those two headaches. A big secondary concern is the ongoing rise in asset valuations, especially in the private markets.
Dong Jang-hun, CIO for Korea's Public Officials Benefit Association (Poba), pointed to this as one of his key focuses. The Korean pension fund reduced its commitment to private equity buyout funds this year to $50 million, from the $100 million to $150 million range of the past three years, he said.
In general, though, most asset owners view elevated asset valuations as a medium-term issue.
“The fact that valuations across a number of markets are above their longer-term averages probably dictates that that’s a headwind for medium-term return expectations over a five- or 10-year period,” said Alistair Barker, head of portfolio construction for AustralianSuper, the largest superannuation fund in the country.
The amount of leverage in the Chinese economy also offers some concern for institutional investors in Asia, given the potential it offers for a credit-induced crisis.
“There are definitely components of the bond market that in a slowing economy, with less support from the government, are going to have their difficulties,” said Charles Scully, CIO for the Asis operations of insurer MetLife.
But global economic growth has been strong enough to reduce credit creation and credit growth in China substantially, so that risk has been pushed out a bit, said Barker.
One concern that engenders little fear today but could quickly gain traction is the prospect of rising inflation.
At the moment, there are no signs of excessive inflation, said Kristian Fok, CIO of Australian super fund Cbus. But the pension fund does take into account a potential pick-up in inflation when designing portfolios.
While a surge in inflation might not take place, even the possibility of it is enough to keep Scully wary.
“If you ask me what are the things that I’m worried about that’s going to add more market volatility and more stress in the financial markets, it would be if [more inflation] happens,” he said.
HOUSING HICCUP
A specific concern for Australia’s asset owner community is a slowdown in the country’s housing market.
The weighted average property price index across its eight state capitals rose by just 2% in the last 12 months, according to the Australian Bureau of Statistics.
A slowing housing market is potentially troubling, given the high levels of home ownership and leverage in Australia’s household sector. By the end of 2017, the ratio of housing debt to household disposable income stood at a record 138.9%, according to data provider CoreLogic. Superannuation funds had 8% of their assets in property as of March, according to the Association of Superannuation Funds of Australia.
“There’d be some concern that if the economy were to slow down; there could be some feedback effects into housing affordability,” said Barker.
In response, the superannuation fund is reducing its exposure to domestic investments and property and raising offshore allocations, Barker said.
Cbus, which has about A$3.5 billion ($2.5 billion) in its property portfolio, believes the assets most at risk are entities that rely on a lot of leverage and haven’t locked in long term debt funding. Banks could also feel the pinch.
“When you get a slowdown in the housing market and potential increase in defaults, the banks ... tend to be adversely impacted,” said Cbus's Fok.
At the moment, it’s not certain the housing market will start to fall, but asset owners are keeping a close eye out.
This is the third part of a series of stories adapted from AsianInvestor's August/September 2018 cover story. To read part one, please click here, and to read part two, please click here.