How Prudential and FWD are adjusting to the late-cycle
With talk of an approaching global recession growing louder after an extended bull market run, yields at rock bottom, and alternative investments increasingly crowded, the quest to eke out meaningful returns is getting harder by the day.
So how are insurance duo Prudential Hong Kong and FWD Group doing it? During a panel discussion at the FundForum Asia event on Tuesday (October 15), their chief investment officers offered the audience some insight into how they approach the issue.
“Clearly if you look at where the valuations are since 2007, we are definitely late into the cycle,” said Paul Carrett, group CIO at Hong Kong-based FWD.
While it's hard to predict when exactly the next recession will unfold, Carrett noted the high levels of leverage currently in the global economy, suggesting any downturn could be extended if companies struggle to pay back debt and governments are forced to cut back on spending to rein in their borrowing.
He said the next big correction might come in the next two to three years.
Ben Rudd, CIO for Prudential Hong Kong, thinks it's more like three to four years.
“But what it'll look like will be very different to the recessions we've seen historically,” he said, noting how the current cycle has already been significantly disrupted on several occasions, with the collapse of crude oil prices in 2015 and the market crash two years ago in which “every single major asset class went down.”
The IMF this month trimmed its global growth projection for 2019 by 0.3 percentage points to 3% – the slowest expansion rate since the last recession in 2009.
Worse still, the organisation’s chief economist, Gita Gopinath, said on Tuesday that central banks worldwide “may have little [ammunition] left when the economy is in a tougher spot” as they have to “offset policy mistakes”.
The fund further added that the US-China trade tensions have jeopardised businesses and investments.
PORTFOLIO OPTIMISATION
As central banks continue to prop up the economy, further interest rate cuts could yet be on the horizon. The Federal Reserve lowered its key interest rate by 25 basis points to between 1.75% and 2% in September, while in countries such as Japan, the interest rates have gone below zero.
With the persisting low-rate environment driving down yields, Rudd said it’s important to optimise the insurer’s global portfolio. Prudential has £151 billion ($192.4 billion) of assets under management in Asia.
“We have a big global portfolio but we reckon that the numbers we are seeing, we are able to increase our returns compared to our historic portfolios by 100 basis points per annum,” he said.
“And this is not by taking risks, I'd be very very clear, this is by optimising the processes we have been doing in terms of our entire portfolio,” he said.
Examples of this include optimising middle office processes in terms of collateral and clearing. The optimisation also comes down to finding the best way to hedge the insurer’s credit portfolio, he added.
Rudd said that the insurer has to adopt these exercises as bonds in Europe and the UK have only generated a meagre level of yields.
“It's not just generating returns, it's about stress-testing your portfolio,” he said, “because if you sit down and say ‘what happens if [the yields of] US 10-year treasuries go to zero,’ which I can see happening in the next recession, and you sit there and say, ‘just going to stop selling [policies],’ [but] that's not an answer.”
“You need to be thinking about how you can really optimise your portfolio so you can operate in a very very different world,” he said, adding that a large portion of the US yield curve will become negative in the next recession.
HIGH YIELD BONDS
As for FWD, which has $33.8 billion of assets under management, Carrett said most of its portfolio is relatively conservative, but between 10% and 20% of the asset allocations are directed towards value-adding strategies.
“In our backyard, in Thailand, or Indonesia, or Southeast Asia or even in Japan, we are finding enough opportunities to fill that 10% [to] 20% of our portfolio, the more interesting things to keep the aggregate yield up,” he said.
Carrett noted that opportunities are emerging in Japanese real estate, but didn’t specify which sub-sectors.
Executives on the same panel were equally optimistic about Asian high-yield bonds.
Adrian Zuercher, CIO Asia-Pacific, head of asset allocation at UBS, said valuations of these assets are “really cheap”, and that they are under the 25th percentile in terms of valuations.
“I completely agree with the Asian high-yield story; it's bulletproof right now,” John Woods, CIO for Asia Pacific at Credit Suisse, but he said that investors will need to “carefully select the issuer” when yields reach about 7.5%.