Nafez Zouk

With Indian debt set to be included in major international benchmarks this year, emerging-market sovereign debt analyst Nafez Zouk travelled to the country to assess its prospects.

Key Points

​

• Why the entry of Indian debt into international benchmarks will be welcomed by emerging-market investors.
• Why the rapid pace of economic growth should help keep the country’s fiscal deficit in check
• Why the quality of India’s institutions helps offset political risk as elections get underway​

Few countries leave such a lasting impression on the visitor as India, steeped in a rich history, and captivating in the intensity of its sights, sounds and smells.

From the moment my plane came in to land in Mumbai, I had a sense of what to expect. Down below, the hustle and bustle of one of Asia’s largest and most vibrant cities was plain to see.

On the way to my hotel, as the taxi driver navigated snarled traffic criss-crossing construction sites for new metro lines, I caught sight of coastal highway expansions and new bridges, indicating the vast scale of the infrastructure projects being undertaken.

Here was visible evidence of the pace of India’s economic growth. According to our estimates, real GDP expanded seven per cent in 2023 and nine per cent the prior year. The International Monetary Fund predicts India will become the world’s third-biggest economy by the end of the decade, perhaps sooner, overtaking Germany and Japan (see Figure 1).​

India’s economic trajectory, coupled with the fact its bonds will soon be listed on the widely tracked JP Morgan Government Bond Index-Emerging Markets (BGI-EM) indices for the first time, have prompted a great deal of excitement among international investors. Ahead of the country’s general election, which started this month and will run until June, I visited to investigate India’s outlook, the prospects for its bond market and the direction of policy.

Positive trends​

India remains an extremely poor country – about 60 per cent of its nearly 1.3 billion people live on less than US$3.10 a day, the World Bank’s median poverty line – but the situation is changing rapidly.^[1] A 2023 report by the United Nations Development Programme said the proportion of the population living in multidimensional poverty – a measure of deprivation across monetary poverty, education, and basic infrastructure services – had fallen to 16.4 per cent by 2021, down from 55 per cent in 2005.

​

A positive demographic backdrop is among the factors that help explain the strength of the economy. India last year surpassed China to become the world’s most populous nation. It is also the only major economic power that could be described as “young”. Moreover, with 44 per cent of people under 25, India will stay that way for some time. Births will continue to exceed the labour replacement rate for the foreseeable future, unlike in China (see Figure 2).

​​Lured by rapid economic growth and a growing workforce, international capital has been flooding into the country in recent years. Prime Minister Narendra Modi is looking to turn India into a manufacturing hub through programmes like “Make in India”, which contains a package of incentives to attract global companies. A host of multinational firms such as Apple, Samsung, Kia and Airbus have been building up manufacturing capacity in the country as they seek a cheaper and friendlier alternative to China.

Apple, for example, plans to make roughly a quarter of all iPhones in India within two-to-three years.^[4] This will help the company minimize its dependence on China. Foxconn, a Taiwanese electronics manufacturer and major Apple supplier, is spending $1.5 billion to set up shop in India as well.^[5] Foreign direct investment (FDI) totalled $71 billion in the 2022–23 financial year, and India’s information technology minister is targeting $100 billion in annual flows “in the next few years”.^[6]

Investing in India

Historically, it has not been straightforward for international investors to invest in India but that is changing. The country’s economic success has in recent years been accompanied by a rise in the number of exchange-traded funds, giving international equity investors access to one of the world’s best performing markets. The benchmark Sensex index last year surged 19 per cent in US dollar terms.

Demand for corporate bonds has also been buoyant in recognition of this economic success story. The extra yield investors demand relative to government debt has fallen while the size of the market has mushroomed, with debt outstanding having grown at around nine per cent a year over the past five years.7

By contrast, international investors have been largely absent from the country’s government bond market. India issues debt primarily in its own currency, in contrast to other emerging market nations which frequently issue foreign currency-denominated bonds. So the only option has been to participate in the local-currency market.

Although local-currency bonds run the risk of adverse exchange-rate movements, they can offer attractive returns. Furthermore, returns from India’s sovereign bonds tend to be relatively uncorrelated to the returns generated by other bond markets, thus helping to boost portfolio diversification.​

The problem is that investing in the Indian market has until now involved jumping through a series of bureaucratic hoops. Not only do international investors have to accept the risk of the rupee depreciating, the rupee itself is not fully convertible. Transacting in Indian bonds is notably more complex than in other EM local-currency markets.

Delhi’s imposition of a withholding tax of as much as 20 per cent on the coupon payments and capital gains received by foreigners has been another barrier to international investment. While other developing countries, such as Colombia and Brazil, also have a withholding tax regime, they are the exception rather than the rule. That makes these countries’ bonds comparatively less attractive, meaning international investors will demand recompense in the form of higher yields or prefer similarly rated sovereign exposure with a lower tax burden.​

Unlike many other nations’ bonds, Indian debt is not euro clearable. From international investors’ standpoint, having to clear trades in India means they do not have the security of dealing with a third-party clearing house that is well known and trusted internationally. Clearing transactions in India also adds complexity as there is an extra layer of rules to abide by and the operating hours are different. That could be especially problematic for US managers, some of whom may have to employ extra staff just to be able to settle trades.​

A new era for Indian bonds

As a result of these drawbacks, the Indian market has been excluded from global sovereign bond benchmarks, creating the biggest barrier of all to greater international involvement. Foreigners own just two per cent of India’s $1.2 trillion outstanding sovereign debt.^[8]

However, this is about to change as a result of India’s inclusion in the JP Morgan EMBI indices from June 2024. Although Delhi began discussing the inclusion of its securities in global indices as far back as 2013, it wasn’t until April 2020 that the Reserve Bank of India introduced a series of securities that were exempt from any foreign investment restrictions under a “fully accessible route”. There are now 23 Indian government bond issues, with a combined nominal value of $330 billion, eligible for inclusion in the world’s most widely tracked emerging-market bond index.

This, together with the effective disappearance of what were once two of the index’s biggest markets – Russia and Turkey – over the previous few years, along with persistent concerns over economic and geopolitical risk in China, has resulted in international investors warming to Indian government debt, which should provide diversification opportunities. JP Morgan said its decision came after 73 per cent of benchmarked investors voted for the country’s inclusion.^[9]​

From June, Indian bonds will make up one per cent of the JP Morgan index. Each subsequent month they will make up an additional one per cent of the index until they eventually comprise ten per cent. With around $230 billion tracking the benchmark, that should ultimately lead to $23 billion flowing into the market.​

Further inflows are likely to result from Bloomberg’s decision in March to also include Indian bonds in its local-currency government indices from January 2025. As with JP Morgan, it says Indian bonds will be included in a phased manner spread over ten months.

While Figure 3 shows the extent to which foreigners have scaled back exposure to almost all EM local-currency debt markets, India is amongst those markets with the most scope to attract foreign investment flows.

​With Indian government bonds offering a nominal yield of just above seven per cent, or roughly 2.5 per cent in real terms on a forward-looking basis, the market is attractive from an investor’s standpoint, especially given India’s economic resilience to the external backdrop.

While overall debt remains high by emerging-market standards at around 80 per cent of GDP, this is broadly in line with countries such as South Africa and Brazil. But whereas relatively weak economic growth means both these latter nations are struggling to get debt down, rapid growth should enable Delhi to make progress in reducing the debt burden.

The Indian government aims to reduce its deficit to around 4.5 per cent of GDP in the coming years. While that is large relative to the pre-pandemic period, much of this increase is explained by increased government spending on infrastructure. That should in turn help buttress economic growth for some time to come, aiding Delhi’s efforts to finance its deficit.

The world’s biggest election

Before India’s bonds are integrated into the index, its citizens are going to the polls in what will be the world’s biggest democratic exercise. Almost one billion people are registered to vote in a seven-phase process that will take six weeks between April 19 and June 1.

Modi, and his ruling Bharatiya Janata party look certain to win the vote. Although the party’s brand of Hindu nationalism has risked stoking social tensions, the prospect of continuity in economic policymaking is likely to mean international investors put such concerns to one side, at least for now.

And I came back from my trip reassured that India is in a very different position to other nations with so-called “strong-men” leaders, who often single-handedly hold the policymaking reins.

The conversations I had during my time in the country bolstered my sense of the high quality of India’s financial and regulatory institutions, and the calibre of the people who lead them. That should help restrain any urge among policymakers to pursue economic growth at any cost. In any case, the government is well aware its recent focus on prudent economic management has been paying dividends.

While Indian bonds do not look especially cheap at current levels, my trip reinforced our positive outlook on the market and we have been adding exposure to India ahead of this summer’s benchmark inclusion. The prospect of sustained inflows in the coming months offers reassurance that downside risks are limited.

Moreover, while India, as a big importer of commodities, remains vulnerable to the threat of higher commodity prices, its economy has become more resilient in recent years. Stronger buffers in turn mean Indian bonds have a fairly low correlation to emerging-market peers. That could encourage many other investors to build overweight exposure as they finally get to join India’s party.

As my plane took off, I had one last glimpse of another urban sprawl – this time of New Delhi, which seemed to have expanded even over the course of my brief time in India. I was struck anew by a sense of the vast opportunities that are likely to emerge in this huge, diverse and fast-changing country over the coming years.

​By Nafez Zouk, Emerging Markets Sovereign Debt Analyst

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Notes:
[1] “Data updates and errata”, The World Bank, December 2023.
[2] “Population pyramids of the World from 1950 to 2100: China”, PopulationPyramid.net, 2023.
[3] “Population pyramids of the World from 1950 to 2100: India”, PopulationPyramid.net, 2023.
[4] Rajesh Roy and Yang Jie, “Apple Aims to Make a Quarter of the World’s iPhones in India”, Wall Street Journal, December 8, 2023.
[5] Rohan Goswami, “Apple iPhone maker Foxconn to invest $1.5 billion in India as it looks to build beyond China”, CNBC, November 28, 2023.
[6] “India eyeing $100bn annual FDI over next few yrs: Min” The Times of India, January 18, 2024.
[7] “India corporate bonds: Outstanding: value”, CEIC, December 2023.
[8] Subhadip Sircar and Cynthia Li, “Foreign money to help PM Modi push near-record India sovereign bond sales”, Business Standard, January 25, 2024.
[9] Ira Dougal, “Explainer: What India’s inclusion in JPMorgan’s bond index means for its markets”, Reuters, September 22, 2023.

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Richard Saldanha

Large tech firms such as Meta have announced they will pay dividends for the first time in 2024, illustrating the opportunities equity income investors can find beyond “traditional” dividend-paying stocks, argues Richard Saldanha in this Q&A.

Read this article to understand:

• The significance of tech firms’ dividend payouts.
• How income investors can take advantage of long-term structural themes in the market.
• How to best manage income portfolios in a higher-for-longer interest rates environment​.
• In February, Meta, owner of Facebook and Instagram, celebrated its 20th anniversary by announcing it would pay a dividend to shareholders for the first time. Later that month, another US tech giant, software firm Salesforce, followed suit. And in April, Google’s parent company Alphabet said it would pay its first dividend.^[1]

These announcements grabbed headlines amid growing interest in dividend-paying companies. Dividends from S&P 500 firms rose to $588 billion last year, up 22 per cent on the figure from 2020. Bank of America analysts say they expect 2024 to be another “banner year for dividends”, citing the importance of regular income in an environment of macro uncertainty. “The dividend is back”, declared The Economist in the wake of the Meta news.^[2]​

In truth, the dividend never went away. Indeed, many tech firms have been paying dividends for some time – including members of the “Magnificent Seven” group, such as Microsoft, Apple and Nvidia – as have companies in other sectors not usually associated with shareholder payouts, such as industrials.

By gaining exposure to these sectors, income investors can diversify their portfolios and potentially take advantage of long-term structural themes, such as the growth of generative artificial intelligence (AI), cloud computing and network infrastructure.

Casting a wider net in this way, rather than restricting allocations to more “traditional” income sectors, could be a particularly useful strategy in the current environment. While fears of a recession have abated and labour markets and consumption look strong, inflation is not yet fully under control. Central banks are expected to cut rates – but when, and by how much, are open to debate.​

In this context, expanding coverage across geographies and sectors should allow investors to identify a broad spectrum of firms that show evidence of recurring revenues and resilient growth, and which could therefore potentially deliver sustained income and capital growth over the longer term. This can help protect capital and provide a hedge against inflation.

In this Q&A, Richard Saldanha, manager of the Aviva Investors Global Equity Income strategy, shares his views on Big Tech, the implications of the higher-for-longer interest rates, and how income investors can manage their portfolios most effectively in the current environment.

Meta, Salesforce and Alphabet have announced dividends for the first time in 2024. What does this mean for income investors?

This news obviously garnered a lot of attention. However, the reality is that it marks the development of a trend we have been watching for a long time.​

The perception of dividend-paying companies is that they usually belong to mature industries with fewer growth prospects, such as telecoms or utilities. Meanwhile, high-growth tech companies have long had a reputation for focusing on other means of capital allocation, such as buybacks or mergers and acquisitions. But the reality is the likes of Microsoft and Apple have been paying dividends for years.

In 2019, S&P launched a new index, the Technology Dividend Aristocrats Index, to reflect the fact more and more tech companies were not only beginning to pay dividends, but also increasing their payouts.^[3] The companies in the index have tended to increase their dividends every year for at least seven years, through different economic environments and significant periods of recession (see Figure 1).

​But while this is not an entirely new trend, the fact more tech companies are now entering the ranks of dividend payers is positive. Companies that announce dividends are making a firm commitment to shareholders that they are going to consistently deliver and grow their cashflows so they can support a dividend over time. And the presence of strong companies like Meta and Salesforce in the dividend-paying universe further broadens the opportunity set for equity investors with an income focus.

How do tech firms’ dividends compare with the broader market in terms of yield and dividend growth?​

Though dividend yields are still not particularly high in the tech sector – Meta’s dividend equates to a forward yield of less than 0.5 per cent, for example – the prospects for dividend growth in these stocks is very attractive given that these firms’ cashflow growth is so strong (see Figure 2).

Exposure to tech firms also gives income investors the opportunity to participate in areas where we know there is a long runway for structural growth, notably generative artificial intelligence, but also cloud computing and digital payments.​

You mentioned AI. What could be the wider implications of the generative AI boom and how are you playing the theme in your portfolio?

​We invest in a range of companies that are linked to AI, not all of them in the tech sector. For example, some notable beneficiaries of AI are in the industrials sector. In fact, many industrials companies now have characteristics in common with technology companies, such as recurring revenues tied to software applications.

AI software adoption is rising rapidly, and large language models (LLM) and AI bots require massive computational power to process and analyse big datasets. High-end graphics processing units (GPUs), which are required for AI processes, generally need three-to-four times as much power as central processing units (CPUs). Thus, the demand for data centres is only set to grow as demand for data increases.

We are seeing “hyperscalers”, or cloud computing providers – namely Amazon, Microsoft and Google – continue to increase their investments into building these data centres. But this theme should also have implications for a number of industrial companies, which are not generally perceived as being driven by AI. Take Schneider Electric: around 20 per cent of its business and revenues come from data centres and it has recently said this part of its business is likely to grow in double digits for the foreseeable future.^[4]

Other potentially overlooked beneficiaries of AI include suppliers of software and databases. These firms have proprietary datasets, which they supply to various end customers such as accountants, healthcare professionals or legal firms. The ability of LLMs to handle the vast amounts of data, but also boost the speed of decision making, is helping these companies improve the service they provide.

Turning from sectors to geographies, where do you see the best opportunities to hunt for dividends this year?

From a dividend growth perspective, the US continues to be the leading market and we have seen payouts grow among a number of the US-listed technology names we invest in. But there are attractive companies in other markets, which is why we believe a global approach is important.

From a yield standpoint, we find companies in Europe represent interesting opportunities and we are still seeing attractive dividends in that market. This is also true of some emerging markets in Asia.

There are also numerous great companies in the UK. Firms such as Unilever, the London Stock Exchange or RELX (information services) are industry leaders and have a global reach, which is important from a diversification standpoint. In our opinion, valuations of UK-listed companies also tend to be relatively more attractive than their US counterparts.

Last year was a challenging one for the “quality” companies usually targeted by income investors. How do you view that category now?

Two parts of the market that are prized for their quality and defensive characteristics, healthcare and consumer staples, were left behind in the Magnificent Seven-driven market rally in 2023. That created difficulties for many equity income investors. The situation was a point of contrast with 2022, when investors sought out these firms for their defensive characteristics amid the wider market drawdown.

But from our perspective, valuations in these sectors are looking particularly attractive now. While we have seen a relative re-rating in the market, we still see healthcare and consumer staples companies delivering resilient earnings and cashflows. In a world still characterised by macroeconomic and geopolitical uncertainty, we believe these companies have a lot to offer in equity portfolios.

Taking a step back to look at the macro picture, where do you see interest rates settle this year? And what would be the implications of a higher-for-longer environment for income investors?

Markets have been very quick to price in rate cuts. At the start of the year a total of seven cuts ­– around 170 basis points (bp) – were priced in for the US Federal Reserve (Fed). Until early February, investors were still expecting the first one to happen in March, but that expectation has been pushed back and there remains uncertainty as to the size and number of cuts we should expect in 2024.

Major central banks are still expected to cut rates this year, and this is good news for equities in general, just as the rate hikes in 2022 were a headwind for markets. However, we do not believe the battle against inflation is won and rates could well remain higher for longer. In our opinion, dividends are likely to remain the best defence against potentially sticky inflation.

For equity income investors, a focus on companies that are growing their dividends is essential. Though this applies in all market environments, it is even more important when inflation could be uncertain and, by definition, interest rates could be higher for longer. In the latter scenario, investors should look for companies with strong cashflow generation who can grow their dividends well above inflation. Casting the net wider to cover non-traditional income sectors can help in this respect.

By Richard Saldanha, Senior Portfolio Manager

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Notes:
[1] Alphabet announces first quarter 2024 results, Alphabet Investor Relations, April 25, 2024.
[2] The dividend is back. Are investors right to be pleased?, The Economist, February 8, 2024.
[3] S&P Technology Dividend Aristocrats Index, S&P Dow Jones Indices, April 2024.
[4] Peter Herweck, “The next frontier – industrial tech for the future”, Schneider Electric, 2023.

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Michael Grady

Aviva Investors, the global asset manager of Aviva PLC (‘Aviva’), expects a steady process of rate cuts from the world’s major central banks this year as global growth remains stronger and inflation somewhat more persistent than expected, according to the firm’s latest quarterly House View.

The asset manager predicts that global growth will be around 3 per cent across 2024. Whilst this is still down from 3.25 per cent in 2023, this is an upwardly revised estimated from the 2.75 per cent that was predicted at the start of the year. This is the result of Q1 2024 seeing growth momentum maintained or moderately improved across most regions. For the United States that has resulted in a better-than-expected start to the year, with consensus growth forecasts revised up for the year as whole.

In the Eurozone, growth is expected to return in Q1 following a year of stagnation. With the effects of higher energy prices fading, an historically low unemployment rate for the region and elevated household saving, there is scope for consumer spending to improve. Similarly, in the United Kingdom a return to growth in Q1 is anticipated, albeit with a slower rate of improvement this year, with ongoing headwinds from higher mortgage costs.  In Asia, the growth outlook remains positive in Japan, although 2024 is expected to be slower than 2023 due to the boost from Covid re-opening earlier last year.

As a result of the growth outlook, while rate cuts are indeed coming into focus, the pace is likely to be steady, rather than rapid. Since the start of the year the market has pushed back the likely timing of the first rate cut and seen the terminal rate of the cycle revised higher. Aviva Investors agrees with that direction of travel for the US and believes there could be a further move that way. However, pricing for the UK has been dragged along with the US, when in fact the economic backdrop looks quite different. As a result, the Bank of England could cut rates sooner and more deeply than is currently priced.

The ECB has been fairly clear that it expects a first rate cut to materialise in June, with the pace of cuts likely to be at a quarterly frequency thereafter. It is expected that the recent policy shift from the Bank of Japan will end yield-curve control (YCC) and raise the policy rate into positive territory, but further rate hikes are likely to come slowly.

Regarding asset allocation, the impending rate cuts, alongside robust corporate earnings, should result in a supportive environment for risk assets. As such, Aviva Investors continues to  be overweight equities, with a relative preference for the US and Japan over Emerging Markets. Returns have been strong this so far year, and whilst this was expected, it seems unlikely there will be a similar pace of equity market returns for the remainder of the year.

However, the team do note that the risk of market ebullience breeding instability is growing. Therefore, the team also prefer to be overweight government bonds to give balance to the asset allocation in the event of a risk event materialising. A more elevated yield environment also makes for a more attractive risk/reward dynamic as we enter a cutting cycle. The preferred markets to be overweight are the UK and the Eurozone, with an underweight in Japan. The team also continue to prefer to be broadly neutral on corporate bonds, with the risk/reward somewhat better in high-yield than investment-grade given the stage of the cycle.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “The start of 2024 has been stronger for markets than initially predicted, particularly in the US, with consensus growth forecasts moving upwards, and the expectation of a return to growth in o the UK and Europe over Q1.

“Rate cuts are certainly on the horizon, and at this time it seems like the ECB will be the first to move, potentially as early as June. However, the Bank of England has the potential to surprise markets by cutting rates earlier and more deeply than what is currently being priced.

“As a result, we expect risk assets to be in focus over the coming months. Whilst global growth figures may well end up being below the levels of 2023, the stronger than expected start to year, twinned with an impending cutting cycle could present a positive backdrop over equity markets over the remainder of 2024.

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Michael Grady

Global economic activity has proved stronger than seemed likely at the start of the year, given the scale of supply-side shocks that had fuelled inflation and eaten into disposable incomes over the previous 12 months. Several indicators suggest growth accelerated in the first half of 2023 as a drop in energy prices lowered headline inflation.

However, Aviva Investors, the asset manager of Aviva plc, believes that the current economic cycle is likely nearing its end. Even though energy prices have fallen sharply, leading central banks have not yet won their battle to control underlying inflation. That suggests interest rates will continue to rise.

This ‘late-cycle’ environment could persist for a while longer, should the global economy continue to defy expectations with its unexpected resilience. All the same, major developed economies still look set for below-trend growth in the second half as the impact on household finances of higher rates saps spending.

Central banks are striving to tighten monetary policy sufficiently to weaken labour markets, deliver softer wage growth and ultimately lower core inflation without causing an economic downturn. However, it is important to recognise such periods usually end with too much policy tightening and recession.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “Returning inflation to central banks’ targets in a way that minimises economic damage is proving challenging, although some progress is being made. It still remains to be seen how much pain will be required to get inflation back to targets of around two per cent. But policymakers are mandated to deliver low inflation and they need to stay the course, even if that means parts of the economy suffer.

“Most equity markets have risen by between ten and twenty per cent this year as investors have sensed that interest rates were close to peaking, and that global economic growth was holding up better than expected. Company earnings, which have tended to surpass expectations, have also helped demand. In the short-term, we are optimistic on equity markets’ prospects, particularly in Europe as earnings are expected to hold up better and valuations are more attractive. But we are more cautious further ahead given the risk of recessions.

“The outlook for government bond markets looks more favourable than three months ago given the extent to which further interest rate increases have been priced in. The obvious, and increasing, danger that higher rates eventually tip economies into recession means we are now overweight the asset class. We see potential opportunities in the US since US interest rates are probably closer to peaking, while UK gilts are in a similar position given a further aggressive hike in interest rates is priced in. Emerging-market debt, denominated in local currencies, may also offer opportunities given the likelihood some central banks will start cutting rates in the second half.

“We are neutral on corporate bonds. The extra yield relative to government debt looks fair given healthy corporate profits and low default rates. But expectations a recession will be averted has led investors to bid up the price of corporate debt.

“We remain overweight cash. Although real rates of interest are negative, there is a prospect of earning a positive rate of return in the not-too-distant future as inflation falls and central banks continue to raise rates.”

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Alistair Way

Chinese firms have powerful AI capabilities. How could the progress of the technology in China differ from the West? Mr Alistair Way, Head of Equities at Aviva Investors explains.

China has struggled to catch up with Western firms when it comes to high-level semiconductor development – and with the recent round of legislative measures in the US, which contain tough sanctions against Chinese firms, it probably never will. Instead, it is devoting more and more energy into areas of technology where it can already credibly be described as the world leader. That means software and AI.

There is a huge amount of data in China, and there were historically far fewer restrictions on the ability of tech companies to use, exploit and own data without protections for consumers than in the West. Although Beijing has introduced laws to improve and modernise the data-protection regime since 2017, companies are still likely to have to share consumer data with the government if ordered to do so. This would give a Chinese government-sponsored AI programme a broader dataset with which to train machine-learning models than is available in the West.

Chinese AI development could go in good or bad directions. For instance, Baidu can claim to be a world leader in safe autonomous-driving technology – that looks a positive trend. Equally, Beijing is making progress in facial recognition and other tech-enhanced ways to monitor, control and exploit parts of society. That is clearly a negative outcome and will be accelerated by new developments in AI.

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Michael Grady

Aviva Investors, the global asset management arm of Aviva PLC (‘Aviva’), has revised growth projections marginally higher on the back of more resilient activity data in early 2023, according to the firm’s latest quarterly House View.

However, it has cautioned that risks remain tilted to the downside, especially in some of the major developed economies. While energy prices have fallen back, the conflict in Ukraine still has the capacity to provide negative shocks. Meanwhile, the full impact of monetary tightening has yet to be felt and although peaks in policy rates are close, we may not be quite there yet.

Despite recent events, Aviva Investors does not believe recent banking troubles are comparable to the situation in 2007/8, with banks far better capitalised overall and there being no equivalent credit bubbles. The latest failures in the sector are more likely a reflection of management quality rather than representing a systemic risk to the global financial system. They do, however, show that higher interest rates will expose vulnerabilities and more may yet be revealed.

Elsewhere, Aviva Investors expects mild recessions to remain possible, but these are likely be short-lived given that private sector balance sheets are in good shape, negating the need for an extended remedial period. However, unless underlying inflation starts to return more convincingly towards target, the period of demand restraint may need to be harsher or longer, implying that central banks will need to keep policy in restrictive territory for longer too.

There is an expectation that headline inflation will fall significantly further in coming months, with core inflation to move down also, albeit at a slower pace. Risks are skewed to the upside. Central banks will remain cautious and watchful until or unless this happens more convincingly, but they will also be monitoring financial conditions more generally. These conditions tightened in the wake of banking wobbles, leading to a downward reassessment of policy rate peaks.

Uncertainties implicit in this macro backdrop mean that financial market volatility is likely to remain elevated. Turning points in the cycle are always associated with such uncertainty, but recent experience has been for this to be especially fast-paced and rapidly changing. In these circumstances it is appropriate to adopt a cautious investment approach until there is greater clarity.

Michael Grady, head of investment strategy and chief economist at Aviva Investors, said: “Following a decade or more of near-zero interest rates and quantitative easing, it should not come as a great surprise that some were unprepared for a higher rates environment. Financial sector balance sheets are more robust than in the lead-up to the GFC, with regulators requiring much greater capital and liquidity buffers for banks. Beyond this, some important rules and “plumbing” improvements ought to stabilise “shadow banks” as well.

“However, confidence can quickly evaporate. In a world of digital banking, deposits can run much more easily than in the past. We therefore remain cautious about the near term, with financial stability risks at the forefront of the mind. 

“It is because of the rapid recovery from Covid, aided by fiscal stimulus and compounded by the hit to supply, that central banks found themselves having to deal with excess demand and inflation way above target. The objective of raising rates is not to cause financial distress, but rather to temper demand across the economy in the short term and ensure a sustainable long-term growth and inflation outcome.

“We have no misgivings about not having many high-conviction tactical or structural asset class views at present, apart from keeping cash levels high. Equities and credit have repriced through 2022, and rate cuts might eventually be appropriate. But for now, inflation is keeping policymakers hawkish, and some loosening is already priced in, keeping us neutral on government bonds. We are broadly neutral on the dollar, but any growth slowdown would still prove a challenge for EM FX.”

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Chinese equity valuations are far from excessive.

With Beijing having signalled it is ready to take additional steps to stimulate spending and investment, and with households having been forced to save during last year’s extensive lockdowns, some commentators believe the government’s target is conservative.

According to Bloomberg, market economists are pencilling in growth of 5.3 per cent for 2023. David Nowakowski, senior multi-asset and macro strategist at Aviva Investors, believes the outcome could be stronger still, pencilling in growth of 5.6 per cent or higher.

Although the precise mechanisms by which the Chinese government will look to stimulate activity remain unclear, most expect it to focus on trying to boost household consumption and certain types of infrastructure investment. Economists polled by Bloomberg see retail sales growing eight per cent and fixed asset investment 5.8 per cent in 2023.

After a sluggish start to the year, when economic activity was held back by high rates of COVID infection, anecdotal evidence suggests a strong rebound is underway. High-frequency data points to activity being well above pre-COVID levels in a wide range of household and business activities. Meanwhile, manufacturing expanded at its fastest pace in more than a decade in February, according to the latest purchasing managers’ report.

Pent-up household demand

Nowakowski expects growth to be especially brisk in the first quarter, given pent-up demand from households and the fact this time last year numerous Chinese cities experienced lengthy lockdowns to prevent the spread of the Omicron variant.

“The first-quarter numbers are pretty much guaranteed to be impressive. Just returning to a normal trajectory means you get very strong short-term growth, maybe as much as ten per cent annualised,” he says.

The improved outlook has propelled Chinese equities sharply higher. The MSCI China Index, having slumped to its lowest level in more than a decade at the end of October, had within the space of three months surged 60 per cent in local-currency terms.

Will Malcolm, global emerging markets equity fund manager at Aviva Investors, says the strength of the rally reflects both the rapid pace of re-opening and the fact valuation metrics, such as price-to-earnings (P/E) ratios, had been driven to historically depressed levels in October.

“The pace of re-opening has been far faster than anyone would have expected,” Malcolm says.

That said, Chinese shares were arguably being priced too cheaply, even allowing for the combination of the zero-COVID policy and anxiety that China’s increasingly authoritarian regime was making the country uninvestable. “There was a compelling case for building stakes in several companies, especially those best placed to benefit from the re-opening,” he adds.

One such share was Tongcheng Travel. Even if the stock might at first glance have appeared to be trading at an appropriate P/E ratio, he says earnings expectations for the domestic travel company were too low.

“We felt the company was almost certain to see a big earnings recovery once people were able to get out and about and travel,” Malcolm explains.

AIA Group was another company seen as having an improving narrative. The stock’s valuation had fallen to a level not seen since Asia’s leading insurer had floated a decade ago. The fact AIA, unlike most of its domestic and international rivals, had maintained its workforce over the past two years despite lockdowns preventing face-to-face meetings between clients and agents, added to the attraction.

“Struggling to maintain state welfare and retirement plans, Beijing wants the private sector to take up the slack. We see AIA as being far better prepared to tap into growing private sector demand for pensions and insurance protection in the post-COVID world,” says Adrian Lewis, senior investment analyst at Aviva Investors.

Trend growth heading lower

However, Nowakowski cautions that even if the abandonment of zero-COVID prompts a rapid recovery in activity, it is important not to lose sight of the fact trend economic growth is heading inexorably lower. While the first half of the year may prove stronger than expected, the second half could disappoint.

“I think the real question is once you get that v-shaped rebound, what’s the trajectory that follows? Looking ahead to next year, growth might be closer to four per cent than people expect,” he says.

Several factors lead him to this conclusion, most importantly the ongoing weakness in the property sector. Even if there are some tentative signs the property market crash may be close to bottoming, evidence is far from conclusive. In any case, there seems a slim prospect of the property market resuming its role as the primary engine of the country’s economic expansion.

“Unlike the previous two deep economic slowdowns, the government is unlikely to look to the property sector to reinvigorate growth as it is not productive enough,” Nowakowski says.

Malcolm says while the re-opening of the economy may have brought some normality back to the property market, the fact remains buyers’ mindsets have changed after the government in recent years stressed housing is for living in and not for speculating and investing.

“While government efforts to ensure everyone has a home could help boost demand, there are a lot of properties being held for investment purposes that are likely to eventually find their way onto the market,” he says.

International reverberations

China’s size means the re-opening of economic activity is likely to reverberate far beyond its own borders. For instance, travel bookings by Chinese residents during the Lunar New Year holidays surged 640 per cent from the comparable period the year before, according to Trip.com Group’s Chinese-language booking website, Ctrip. Bangkok, Singapore, Kuala Lumpur, Chiang Mai, Manila and Bali were the top destinations.

Nowakowski envisages the recovery in Chinese tourist numbers will put upward pressure on inflation in western economies too.

“Lots of Chinese people, especially among the middle class, have not been able to get out since the pandemic. Any recovery in Chinese tourism is likely to have a pretty big impact on leisure and hospitality businesses in many countries,” he says.

However, while the government may look to boost spending on public housing and other areas of infrastructure, such as renewable energy plants, it is unclear this will provide as much of a boost to global commodity markets as some anticipate.

Nafez Zouk, emerging-market sovereign debt analyst at Aviva Investors, says since the recovery looks like being consumption led, it is likely to impact other emerging bond markets in a very different way to previous spurts of Chinese growth.

“Increased consumer spending in China should provide a lift to countries dependent on Chinese tourism. But concerns over levels of debt mean Chinese authorities are likely to want to avoid pushing too hard on infrastructure or real estate spending. We would expect less of a boost to commodity exporting nations such as South Africa and Brazil than in the past,” he says.

Beware Beijing’s policy agenda

Malcolm and Lewis believe it is more important than ever for investors to be aware of Beijing’s policy agenda. For some areas, such as semiconductor companies, that could mean a more favourable environment as Beijing tries to build up its domestic capabilities as a means of circumventing US sanctions.

By contrast, other companies are going to be up against a more interventionist government. For instance, Lewis believes mortgage lenders may struggle as the government seeks to put downward pressure on mortgage rates to ensure households can keep up with payments and have more disposable income.

Given the steep recent recovery in share prices, Malcolm believes investors should be discerning about their exposure to the Chinese market. However, he argues Chinese equity valuations are far from excessive, especially when one considers many large international investors remain underweight the market.

Even if the rapid recovery in economic activity proves to be only temporary, he believes there will continue to be investment opportunities.

“The universe is so deep and so broad there is always going to be an opportunity to stock pick. With China representing as much as a third of the global emerging-market equity universe, it is unlikely we are going to say China is uninvestable and in danger of becoming another Russia in the eyes of global investors,” he says.

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Shiqi Wang

Aviva Investors, the global asset management business of Aviva plc (‘Aviva’), today announces that it has appointed Shiqi Wang as Client Solutions Director, Global Client Solutions, Asia Pacific.

Shiqi will be based in Singapore and will report to Richard Surrency, Head of Asia Pacific, Global Client Solutions. In this role, Shiqi will work closely with the local client services team to accelerate the growth of the business, expanding Aviva Investors’ distribution capability and covering the regional insurers and will play a key role in leading Aviva Investors’ global financial institutional strategy across the region.

Shiqi comes to Aviva Investors with seventeen years of industry experience, bringing an extensive history in asset management and institutional sales. Previously, she worked for Algebris Investments in Singapore, where she led business development and investor relations in Asia and the Middle East. Prior to that, Shiqi was an Investment Consultant with Mercer, where she provided investing consulting advice on portfolio construction and multi-asset investment management to institutional clients in the Middle East, Africa, and Asia. She also has experience with Australian institutions, having worked for ANZ’s Singapore office for more than seven years.

Shiqi’s appointment is another senior hire for Aviva Investors’ Asia Pacific client team and follows that of Richard Surrency, who joined the business in late 2022.

This appointment underlines Aviva Investors’ commitment to strengthening its presence in the region and continuing to provide Asia Pacific institutional investors with access to global investment solutions including global equity, credit, and real assets.

Richard Surrency, Head of Asia Pacific, Client Solutions at Aviva Investors, commented: “With a heightened strategic focus in the Asia Pacific region, Shiqi’s appointment marks a key milestone in the firm’s regional growth strategy. In 2023, we are expanding our relationships across the region, and Shiqi’s wealth of experience and industry expertise will be invaluable given the significance, scale and potential growth opportunities in this region.”

Shiqi holds both designation as a CFA and CAIA charter holder. She has also earned CFA Institute’s Certificate in ESG Investing and BA Honours in Accountancy from Nanyang Technological University in Singapore.

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Reporting to Steve Waygood, Chief Responsible Investment Officer at Aviva Investors, Nick will help develop and deliver Aviva Investors’ macro stewardship programme, with an emphasis on promoting the net zero transition at a sectoral level, as well as helping to identify and advocate for specific government policies that would drive a just transition, starting with hard-to-abate sectors such as energy, heavy industry, aviation and shipping. He will formally begin his new role in June.

Aviva Investors’ macro stewardship programme focuses on engagement with governments, policymakers and other key stakeholders to correct market failures on sustainability issues. It complements the asset manager’s corporate governance activities which relate to engagement at a corporate level and influencing the companies and physical assets the business invests in.

Nick joins from his previous role as Executive Director at the Aldersgate Group, a cross-economy membership organisation focused on accelerating the UK’s transition towards a competitive, resource efficient and net zero emissions economy. At the Aldersgate Group, Nick led the overall strategic direction, work programme and policy advocacy activities of the Group for the last eight years, covering all key areas of climate and environmental policy, as well as green finance.

Steve Waygood, Chief Responsible Investment Officer at Aviva Investors, said: “Nick is a hugely respected figure on a broad range of sustainability issues, and I have long admired his work at the Aldersgate Group and before. He brings an unrivalled amount of expertise in this field. His experience of engaging with companies, financial institutions, regulators, governments and policymakers will be invaluable. I am greatly looking forward to working more closely with him and continuing to advance our macro stewardship programme, which has considerable potential to help power the transition towards a sustainable future.”

Nick Molho, Head of Climate Policy at Aviva Investors, said: “Aviva Investors is an organisation I hold in high regard, and one which has been taking material action to shape the transition towards a sustainable future from within the private sector by actively engaging with real economy businesses and financial institutions, as well as with global governments, regulators and standard setters. Such activity is critical in ensuring capital flows into the right activities in the global economy and leads to meaningful change. I look forward to using my knowledge and experience to build on Aviva Investors’ achievements to date and supporting its ongoing work in calling for a timely and successful transition to net zero emissions.”

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• Whether rising yields mean bonds offer value to investors
• How the list of the world’s biggest companies has changed over timeThe fluctuations in oil prices

A new era for fixed income?

Bond yields have reached their highest levels in a decade. Yet the question still needs to be asked. In a world with higher inflation and a higher “risk-free” rate, do newly issued corporate and government bonds offer decent value?

Where did all the Japanese companies go?

In 1989, 14 of the top 20 biggest companies in the world by market capitalisation were Japanese. However, after 30 years of deflation and stagnation, there isn’t a single Japanese company left on that list. Only one – Toyota – makes the top 50.

Meanwhile, 15 of the top 20 are now US based, four of the tech giants – Apple (#1), Microsoft (#2), Alphabet (#4) and Amazon (#5) – make the top five, while Meta is in 14th position. It will be interesting to see whether that composition changes in 2023, with high valuations and a more challenging earnings environment presenting headwinds to tech stocks.

The price of oil

Oil prices, along with other commodities, soared following COVID-19 and Russia’s invasion of the Ukraine in early 2022. But from June 2022, the price has fallen sharply amid concerns of a global economic slowdown, a milder winter and the efforts of countries to diversify supplies and accelerate the shift to renewables.

As for what happens this year, the big question is whether a slowing growth outlook in the US and Europe will be offset by rising Chinese demand as its economy finally reopens after severe COVID-19 restrictions.

Reference
[1]  “Largest companies by market cap”, CompaniesMarketcap.com, February 20, 2023

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