Dresdner MPF funds shift to bonds

Over the next three months Allianz Dresdner Asset Management (ADAM) is going to shift its Hong Kong retirement scheme plans in the face of inflation threats, with its balanced funds increasing allocations to fixed income and decreasing exposure to equities, says Mark Konyn, CEO, Hong Kong. Within equities, however, the firm will retain its overweight to Asian equities, which it expects to continue to outperform US and European equities.

Today the balanced funds are 2% overweight equities and have a sizeable allocation of 4% to cash, which is meant to blunt their exposure to interest rate rises. ADAM manages $5.6 billion in MPF assets and $13 billion for Hong Kong retirement schemes overall.

The 2004 investment outlook is dominated by inflation pressures, particularly due to expensive oil. This has led to concerns that the US Federal Reserve may be late in raising interest rates. The Fed has apparently allowed the bond market to price in an expected rate rise, as opposed to simply jacking up rates like it did in 1994, which caused a shock. ADAM is predicting the Fed will raise the Fed Funds rate twice by 25bp each before the end of the year. He believes yields on the US 10-year Treasury bond, still rising from 2003 lows, will stabilize around 5.25% by the first quarter of 2005.

Konyn notes that within the fixed income world, US sovereign debt has not performed well year to date, but Treasury Inflation-Protected Securities (Tips) have, providing a return of 1.8% so far in 2004. With the markets obsessing over the price of oil - now $42/barrel - ADAM is increasing its exposure to Tips. It is also underweight US 30-year Treasuries.

That said, ADAM does not believe inflation is going to become a massive problem. Although it believes that if very high oil prices continue for several more months, the risk of a global recession grows, it does not think this will in fact occur. Its view is that the price of oil will stabilize around $33-35/barrel by the end of the year, which is above the market consensus of $28/barrel that prevailed at the start of the year, but is not a disaster. The present price is based on speculation over supply fears. While political unrest in the Middle East will continue, OPEC is making a real effort to expand supply.

Thus with mild inflation and higher yields in fixed income on the way, ADAM is taking some risk off the table and switching more assets to global bonds.

On the global equities front, markets have been oiled by interest-rate expectations and fears of China exporting its rising inflation. This has led to US investors repatriating money from Asia, providing a fillip to the dollar's value.

Carry trades will continue to unwind as US interest rates go up. This means China's balance of payments will turn negative by mid-2005, but its GDP growth story will remain intact, says Konyn. His firm's view is that China's boom-bust cycle is stabilizing and overheating is specific to sectors like property but is not endemic of the entire economy. And for now the question about revaluing the renminbi is not on the agenda, so this will not disturb the markets.

The question is how Asian companies will handle inflation pressure. Will they be able to raise prices and preserve their earnings margins? Adam seems to think so, which will allow companies in Asia to outperform peers in America and Europe. In sector terms, ADAM has moved into consumption and financial plays and is underweight utilities; it also likes financials and property in Japan.

Despite mild inflation, Hong Kong retirement funds should remain in good fiscal shape, Konyn says, as salary inflation in Hong Kong will remain muted and unemployment levels will not change.