Aberdeen Asset Management: Investor opportunities in 2018

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Aberdeen Asset Management - Where should investors look for opportunities in 2018?

Hugh Young, Managing Director of Aberdeen Asia shares his views.

Where should investors look for opportunities in 2018?

After a turbo-charged 2017 investors have become nervous of a market sell-off. Among the signs: technology stocks have wobbled recently; high yield corporate bond spreads - the risk premium corporate bonds provide over government bonds - have narrowed to levels not seen since the financial crisis; and speculation has driven a bitcoin frenzy.

 

Here’s how we see it. Global growth is improving; European exports are up and so is investment; Chinese growth is not slowing as quickly as everyone had feared a year ago; and Japan is also delivering better GDP numbers. Among global emerging markets, several years of deleveraging and balance sheet repair are now over. 

 

These developments are positive for equities in particular. While interest rates will start to go up, central banks remain vigilant to the risks of tightening too quickly. They will make sure liquidity does not evaporate. Meanwhile, corporate profit margins and earnings are on the rise, in many cases leading to better dividend payouts. 

 

Even so, it is prudent to be prepared for a correction. The economic backdrop remains attractive, but some technical signals are flashing. Around 40% of high yield bond issues will mature in 2020-2022, meaning that the companies affected may have to brace themselves for higher funding costs.

 

Spreading Risk

 

Rising interest rates are not universally bad for bonds, however. There are several strategies investors might want to consider that spread risks and offer upside. 

 

We are enthusiastic about emerging market corporate bonds. This is a large asset class which is well-diversified both across sectors and geographically. Around 60% is investment grade. Unlike hard currency sovereign debt, the asset class held up well when the US Federal Reserve (Fed) initiated its taper of bond purchases in 2013. 

 

Another attractive idea is frontier bonds. These may sound risky, but we think there could be rewards for investors prepared to undertake proper due diligence. For example, Egypt and Sri Lanka emerged from International Monetary Fund programmes and, after devaluing, they provided a window for investment. There are others like them. 

 

The average spread in yield for hard currency (dollar or euro) corporate bond issues above government bonds is currently four percentage points. In effect, you are being paid for the risk you take. This will cushion any volatility caused by US interest rate rises. Similarly, the average yield on local currency bonds will help buffer adverse currency movements. 

 

Neither of these ideas have been widely adopted by investors – and that is exactly the point. A sudden rush for the exits must be a concern across many, more popular, assets markets, especially those where foreigners own a big chunk of debt (almost 40% in the case of Indonesia, for example).

 

Indian Promise

 

One country that is generating strong economic growth and benefiting from government reforms is India. The equity story here is well known. Less understood is India’s fixed income potential, both from the point of view of attractive risk-adjusted returns and as a portfolio diversifier. Real yields compare well with anywhere in the emerging market universe. 

 

Yet when we surveyed 160 local currency funds earlier this year, remarkably we found that the typical exposure to this market was just 1%. Their reluctance is mainly due to capital controls which make moving money across borders more difficult. 

 

Continuing the diversification theme, investors might also consider an allocation to non-traditional assets. For income investors there are opportunities in infrastructure or subsidised energy such as windfarms. 

 

Such assets compare favourably with high yield bonds. Equally, by venturing into other areas such as peer-to-peer lending, catastrophe bonds or aircraft leasing, investors may find total returns similar to equities - but at half the level of risk.

 

The Tech Dilemma

 

Ah yes, equities. For many the ascent of technology stock prices, whether these be FAANGs (Facebook, Apple, Amazon, Netflix and Google) or China’s BATs (Baidu, Alibaba and Tencent) poses the classic dilemma. If you missed the rally, should you chase it further? And if you are already invested, for how long do you hang on? 

 

Tech is not in a bubble (as it was in 2000) even if it is expensive and, with just a handful of stocks responsible for broad market gains this year, the very definition of a crowded trade. But there are real earnings behind these stock prices. In Asia, the shift to e-commerce and cashless payment systems promises to change business profoundly. 

 

Technology disruption is being felt across industries, helping to prolong the current investment cycle. 

 

Indeed, technology disruption is being felt across industries, helping to prolong the current investment cycle. We see banks as big beneficiaries. In Asia, they have had a good run and remain cheap (around 1.2x price to book if you strip out the Chinese banks). This is especially the case now that compliance and regulatory pressures seem to have receded. 

 

The return of earnings growth after some years of static - or even negative - returns is welcome. True, there are areas of concern: Singapore’s lending to commodity companies, say, or the overstretched consumer in Malaysia or Thailand. The key is to be very discriminating when selecting individual company names. 

 

Overall, compared with 12 months ago, we like what we see. Back then, investors were betting that the unexpected victory of Donald Trump would lead to rising inflation and a continued strong dollar. As it happened, the dollar soon peaked (it was already fully valued). 

 

Equities have since powered on. A global recovery is re-kindling animal spirits. There are risks, of course, but for the next six months there is also scope for positive surprises. 

 

Important Information 

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested. Past performance is not a guide to future results. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. We recommend that you seek financial advice prior to making an investment decision. The details contained here are for information purposes only and should not be considered as an offer, investment recommendation, or solicitation, to deal in any of the investments mentioned herein and does not constitute investment research as defined under EU Directive 2003/125/EC. Aberdeen Asset Management does not warrant the accuracy, adequacy or completeness of the information contained herein and expressly disclaims liability for errors or omissions in such information and materials. Any research or analysis used in the preparation of the information has been procured by Aberdeen for its own use and may have been acted on for its own purpose. Some of the information may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies. These statements are only predictions, opinions or estimates made on a general basis and actual events or results may differ materially. No information contained herein constitutes investment, tax, legal or any other advice, or an invitation to apply for securities in any jurisdiction where such an offer or invitation is unlawful, or in which the person making such an offer is not qualified to do so.

 

Author

Hugh Young

Managing Director of Aberdeen Asia

Aberdeen Asset Management


January 2018

Please note that these are the views of Hugh Young, Managing Director of Aberdeen Asia and should not be interpreted as the views of RL360.

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A range of Aberdeen Asset Management funds can be accessed through our guided architecture products Oracle, Paragon, Quantum, Quantum Malaysia, LifePlan and Protected Lifestyle, and also through our PIMS portfolio bond.