Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
1 September 2021
“Tapering could start in 2021 – No rate hikes just yet”
“I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.” – Powell said in his closely watched Jackson Hole Speech.
Fast forward through the shortest recession on record and the economy is rebounding strongly. The Fed’s economic forecasts for the end of 2021 show economic growth rising at a 7.0% pace, core inflation at 3.0%, and an unemployment rate of 4.5%.
As the economic outlook continues to improve, it is not surprising that the Fed would start scaling back its stimulus. Although it is waiting for “substantial further progress” towards its dual mandate of an average inflation target of 2% and full employment, it looks like those benchmarks may be reached sooner rather than later, given its forecasts for 2021.
Figure 1: Federal Reserver Balance Sheet (Source: Bloomberg)
In theory, tapering should lead to higher interest rates. By tapering its asset purchases, the FED is signaling that policy is becoming less accommodative. However, since the markets and the Fed have experience with the process, we expect the markets to start pricing in the taper.The key to the market’s reaction will be based on how quickly the Fed is willing to taper and whether or not it would be inline with the economy’s growth.
That being said, the situation remains very dynamic and fluid, investors should remain cautious and expect even more volatility towards the end of the year. We continue to recommend a more defensive and diversified portfolio allocation, taking advantage of any volatility through the use of tactical trading strategies.
Fixed Income Overview:
Investors seem to be turning their attention to Treasury yields as a form of precaution. We anticipate FED Funds rate to be kept 0% – 0.25%, with two rate hikes by the end of 2023. The 10-yr US Treasury rebounded to 1.33% as of1 September 2021 from 1.26% as of17August 2021 and is expected to be around 1.0% to 2.0% for the year of 2021. However, we do foresee a likelihood for Treasury yields to increase further towards to the end of this year, depending on the economic data and Fed’s policy stance.
The credit default swap (CDS)index for Asia ex-Japan Investment Grade entities dropped from 83 as of 17 August 2021 to 66 as of 1 September 2021. Asia IG credit spread decreased to 122 as of 1September 2021 from 132 as of 17August 2021.The IG bonds market have stabilized significantly over the recent months. Asia HY credit spread rebounded slightly from 815as of17August 2021 to 818 as of1 September 2021. However, the current credit spread levels still remain relatively high.We expect sentiment in the HY bond market to remain relatively weak as there continues to be adverse news emerging out of the Chinese market.
Figure 2: CDS Asia ex-Japan Index 1-year Chart (Source: Bloomberg)
Highly leveraged HY bonds (B rated) may face refinancing/default risks – several onshore/offshore bonds have defaulted recently including bonds issued by Tsinghua Unigroup, China Fortune Land Development, Tus-Holdings Co. Ltd., Sichuan Languang Development and Sunshine 100 China Holdings. As the government support weaken, four Chinese AMCs (Huarong, Cinda, Orient & Great Wall) may be downgraded and their credit spreads may widen. We caution investors holding marginal investment graded bonds (BBB-, Baa3) to be wary of downgrades. For investors with an investment grade bond portfolio mandate, we recommend bonds with BBB+ ratings or higher, and portfolio duration of 3 – 4 years.
We again recommend investors to stick to short dated high quality (BB Rated) High Yield bonds with a duration of less than 3 years and reduce their exposure to highly leveraged BB-rated bonds (Greenland, RiseSun) and all B-rated Chinese real estate bonds. Investors should be prepared to hold their bonds to maturity. Geographically, we are overweight Emerging Markets’ bonds (Investment Grade and High Yield with BB ratings excluding China) and neutral on Developed Markets’ and Chinese bonds.
Further, we recommend investors to match their exposure of high-beta bonds such as: CoCo Bonds, Perpetuals, and high yield bonds to their respective risk appetites. It is also recommended for investors to hold a more diversified fixed income portfolio or to reduce leverage of portfolios due to various uncertainties across sectors. We advise investors to dive deeper into the issuer’s stand-alone fundamentals to ensure the strength of the company.
We recommend investors to continue to monitor low beta bonds. For reference, the purchase yields for 3–5-year low beta IG bonds are at 1-2%, and 3-5-year low beta HY bonds are at 3-5%. Overall, we recommend a balanced and more diversified portfolio of high quality (BB rated) high yield bonds and short duration IG Bonds. Although the absolute returns in the fixed income market may be low, it is still advised to maintain a portion of the portfolio in fixed income given the heightened volatility of the markets.
Over the past two months, we have recommended investors to start increasing their exposure in the US vs Greater China. Generally, volatility has continued to be much more muted in the US vs Greater China. The Dow Jones Industrial Average has also outperformed the HSI significantly over the same period.
Figure 3: Year-to-date chart comparing Dow Jones Index and Hang Seng Index (Source: Bloomberg)
However, we are beginning to see some value in the Greater China market. Select sectors such as Technology, consumer discretionary and healthcare continue to demonstrate strong fundamentals and are likely to be long term additions to our core portfolio. Regulatory risks continue to be an overhang in the region, but we think that the worse is likely to be priced in to certain extend.
Geographically, we recommend gradually increasing our Greater China exposure on the recent pullback while maintaining our core blue chip portfolio in the US.
Although both fiscal and monetary policies look set to remain relatively accommodative in the short-term, there are signs that the FED might begin to taper its asset purchases by the end of the year. We urge investors to stay constructive and selective in terms of stock selection and weigh their risk-and-reward. Volatility will persist, and investors should lean towards a more conservative portfolio.
Our investment strategy stays largely intact. We prefer sectors such as cybersecurity, consumer discretionary, select technology and healthcare. We recommend US Mega-Capitalized Companies which are constituents of the Dow Jones Index as they are less volatile and still provide decent upside potential.
It is important that investors adopt a well-diversified and balanced portfolio, with a skew towards cyclicals while maintaining a core thematic position in technology. In short, investors should employ a more back-to-basics stock selection approach and continue to adhere to company fundamentals and strict risk management principles (stop-loss mechanisms and/or appropriate portfolio hedging) to mitigate risks from market swings and uncertainties.
This material is provided for informational purposes only. It is not a recommendation or solicitation of any investment or investment strategy. There is no guarantee that any investment or strategy will achieve its objectives. Unless otherwise stated, all information contained in this document is from Raffles Assets Management (HK) Ltd. and/or Raffles Family Office Pte Ltd (Singapore) and is as of 1September2021. The views expressed regarding market and economic trends are those of the authors and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets, or sectors will perform as expected. By acceptance of these materials, you agree that you shall use the information solely to evaluate your investment in this Raffles Assets Management (HK) Ltd and/or Raffles Family Office Pte Ltd (Singapore) sponsored investment opportunity and you shall keep the information confidential.
Derek Loh – Head of Equities
Mr. Derek Loh is the Head of Equities at Raffles Family Office. Derek has numerous years of work experience from top asset management firms and Banks – 13 Years on the Buy-side across 3 Major Cities in Hong Kong, Singapore and Tokyo. Derek demonstrates in-depth industrial knowledge and analysis, covering mostly listed equities.
Ex-Portfolio Manager for ACA Capital Group, managing a multi-billion dollar global fund for a world-renowned sovereign wealth fund and reputable institutional investors. Previous notable Investors serviced include Norges Bank (Norwegian Central Bank), Bill & Melinda Gates Foundation and Mubadala. Derek holds an Executive MBA from Kellogg School Of Management and HKUST. He is also a CPA.
Lawrence Chan – Head of Fixed Income
Mr. Lawrence CHAN is Head of Fixed Income of Raffles, where he is responsible for credit and fixed income investments.
Mr. CHAN has over 15 years of experience in the fixed income industry. Prior to joining Raffles, he was Chief Investment Officer (Fixed Income Investment Department) of Taiping Assets Management (HK) Co. Ltd. to manage China Taiping Group’s offshore bond investments and co-manage MPF & ORSO funds for China Life Trustees. His co-managed China Life Guaranteed Return Fund won various awards from Bloomberg Businessweek (2015-2017), BENCHMARK (2015) and MPF Ratings (2015-2016). He had worked for various financial institutions, including Taikang Asset Management (HK) Co. Ltd., Deutsche Bank AG (HK Branch) and Hong Kong Monetary Authority.
Mr. CHAN graduated with a Master’s degree in Finance from The Chinese University of Hong Kong and a Bachelor’s degree in Accountancy (with First Class Honours) from City University of Hong Kong (formerly known as City Polytechnic of Hong Kong). He is a CFA charterholder, Hong Kong CPA, and a Fellow of the Association of Chartered Certified Accountants (“ACCA”).