Will markets end the next 12 months higher than they began? While it would be nice, it isn’t crucial to successful investing, suggests one of the world’s most successful fund managers.
It is what investors do along the way that is most important, according to Fidelity Worldwide Investment (Fidelity).
“The outlook for the new financial year may seem to be a ‘groundhog’ year, with an apparent repeat of the past 12 months,” says John Ford, Chief Investment Officer Asia Pacific at Fidelity.
“There will be continued market volatility, downgrades, rescue packages, quantitative easing and continued concern of China slowing. We have seen all these in the past 12 months and look like seeing them again this financial year.
“Politics will drive markets this year. Ongoing global debt reduction will slow global economic growth for a sustained period.
“However, while it is expected to be a low growth world, not all sectors are performing poorly. Some have done and continue to do well.
“Investing in assets that provide real returns irrespective of daily market movements is more important than ever,” says Mr Ford.
“One way to do this is by investing in corporate assets, as much of the corporate sector is doing better than governments and sovereign investments.
“Assets like corporate bonds, high-dividend paying companies and some property funds are rewarding investors whether the market moves up or down.
“Corporate balance sheets, in particular in Asia, are stronger than ever. Many companies have paid down debt and locked in low interest rates and continue to generate income.
“Many of these corporates are rewarding their investors with returns, be it dividends or bond yields.”
Mr Ford notes “dividends will form an increasingly important part of returns to shareholders. While, for the past 20 years, investors have bought equities for capital growth it is the time to buy equities for income. Studies show that investing in income-generating shares (and reinvesting the dividends) is one of the most lucrative ways to invest over the longer-term thanks to the compounding effect on returns. History shows that high-dividend stocks tend to outperform other assets in periods of sluggish economic growth – which is exactly what we face now. Companies that pay dividends are often high-quality companies with stable and reliable earnings streams that tend to hold up well during periods of market volatility. Dividend-focused indices have tended to outperform the broader averages so far this calendar year.
“Yet at present, whether a company is a good quality company, low quality company, high growth, low growth; they are trading around very similar ranges. We think there should be differentiation, there should be discernment in the market – and there will be at some stage – and that’s where we see opportunities for longer-term investors.
“Asian companies that can deliver a high and sustainable dividend yield or are still growing in today’s low-growth world, or both, will be bid up by the market. They are the ones we want to own. If you have an investment horizon beyond the next year or two they should provide a nice investment opportunity.”
Fidelity’s portfolio managers tend to favour companies with strong balance sheets, which do not rely on banks for funding. We also look for firms that own assets where supply / demand is tight, which sell products that all of us need on a daily basis, or companies that are doing something truly innovative, which gives them pricing power. These are what most of our managers want to invest in.
Institutional investors in Asia – such as pension funds, insurance companies and sovereign funds – are already increasing their investments in equities. Wholesale and retail investors will follow these institutions – eventually.
Among fixed income investments, Mr Ford notes “there have been substantial inflows into the traditional havens of US 10-year Treasury-bonds and German Bunds. We have also seen investors moving into other high-quality bond markets such as Canada and Australia, in an effort to escape eurozone uncertainty. But long term, the levels of their interest rates are unsustainable and will weaken.
“Our portfolio managers favour high-yield and investment-grade corporate bonds; again because many of the corporates that are offering them are in comparatively good financial shape.
“We’ve also seen an increased appetite for Asian bond markets, as many Asian economies do not have the same debt problems faced by the eurozone and many other developed markets. In particular, demand for Asian investment-grade bonds is increasing. Investors are also looking at Chinese RMB bond funds, where the appreciation of the currency is now available to global investors.”
Mr Ford notes there are also investment opportunities in the property sector. This is generally funds investing in second-tier property, which is starting to catch-up toward prime prices in some markets. But you have to be selective.
Looking at foreign exchange markets, traditional currencies such as the US dollar, Swiss franc and the yen have performed predictably well, while emerging market currencies have suffered.
Another factor in Asia’s favour is falling inflation and the healthy fiscal positions of many Asian governments. Mr Ford notes “China, Hong Kong, Singapore and South Korea all have strong budget surpluses, which give their governments more room to act if the global economy slows down further. In fact, we see scope for eight out of 10 central banks in Asia to cut interest rates. This lower inflation and the return of more growth focused policies should be positive for Asian equity markets.
“Markets where we are finding investment opportunities include Indonesia, South Korea and Thailand. For example, Indonesia is expected to be one of the next countries to join ‘club’ of countries that generate a GDP of more than a US$1 trillion a year. Only two emerging market economies, South Korea and Taiwan, have had sustained GDP growth of over 5% for five decades.
“We also like companies in China and Korea for their attractive valuations with single digit price to earnings rations (P/Es). Thailand just reported GDP of over 11% in Q1 versus Q4 as the country recovers from the floods there late last year and continues to demonstrate healthy domestic demand.”
Mr Ford points out that “asset allocation is no longer a decision of how much to invest into fixed income compared to equities and how much diversification into property, alternatives, commodities or other asset classes. It is more about the types of assets in each class. And that allocation will vary with each investor’s risk and retirement requirements.”
He acknowledges that investing in Asia, be it Asian equities or high yield bonds, in today’s volatile markets is not without risks, such as external shocks from the issues in Europe and the US. This is why he suggests an active bottom-up approach to find the best investment opportunities, assessing individual investment opportunities and individual companies – as each country and company is impacted by macro events differently.
4 July 2012