Wealthy investors “too focused” on fixed income

The focus of wealthy individuals in Asia on the historical returns of fixed income funds risks leaving them poorly placed for market conditions in the coming years as economic conditions shift, warn some fund selectors and Eastspring Investments.

The Singapore-headquartered asset management company hosted a roundtable on June 27 that featured fund selector representatives from Credit Suisse, DBS Private Bank and UBS Wealth Management, as well as Eastspring chief investment officer Virginie Maisonneuve and global emerging markets portfolio manager Andrew Cormie.

Cormie noted that a shifting interest rate environment, ultra-low market volatility and high US equity valuations had combined to provide a benign environment for global emerging market equities. While emerging markets underperformed for several years after 2010, they have done well in the last year.

The MSCI Emerging Markets index rose 11.19% in 2016 after dropping 14.92% the year before. It gained a further 17.25% between January and the end of May, and Cormie believes that there is more to come.

“That is the message we have been telling our clients for the past six to nine months,” he said. “We don’t know exactly what will happen or what the catalyst will be but the next five years will be different to the last five, and if your portfolio is constructed based on the last five years you risk missing out on significant returns.”

He added that notable changes included the fact that US quantitative easing had ended and US interest rates were slowly increasing, as some signs of inflation began to return, and the fact that excess production capacity globally had either been used up or was close to being used up.

However, the attending bank gatekeepers noted that their clients have tended to use leverage to enhance their returns from fixed income funds, which has proven to be an effective way to double the recent average 4% to 5% returns of these products as interest rates have continued to fall and yields have narrowed.

“The reality is fixed income made very good returns for years, and [the global financial crisis of] 2008 is still very fresh in clients’ minds,” said one. “If you are looking at returns of 5% to 10% after leverage, it’s hard from the client perspective to take more risk to get similar kinds of returns.”

Home bias

The appeal of investing into global EM equities is also not helped by the fact that Asian wealth clients tend, as with most investors, to have a distinct home bias, or that they largely live in emerging markets.

When combined with their naturally more hands-on style of investing, compared with their counterparts in the US or Europe, this means high-net-worth investors are more likely to favour investing in stocks themselves. The more illiquid and less transparent nature of bonds, in contrast, has led them more to trust fund investing.

Investors in the region also tend to be less willing to accept the portfolio-based approach of investing, preferring to focus on targeted risk taking.

“Asian investors don’t tend to invest on investment principle but on conviction,” said another fund selector. “It’s a difficult conversation to have with a client to say ‘why don’t you diversify your portfolio into this?’ and when they ask ‘what is your view on it?’, you have to say ‘we are negative but you should still do it, for the sake of diversification'.”

Maisonneuve noted that this is something that should change in order to better preserve client wealth.

“My view is that there will be increasing tail risks due to events that you can’t insure against except by keeping bonds in your portfolio, but you still want risk assets as cash returns are very low and emerging markets can help you diversify [away] from [exposure to rate moves by] the Fed,” she said.

“Added to that, there are transformations affecting these asset classes globally, such as technological disruption and demographic changes," added Maisonneuve. "There are a lot of positive trends that will support further emerging market performance.”