07 December 2021
“Omicron is here. What does it imply?”
“The FED has reiterated that they are closely monitoring inflation data and they will not hesitate to act if necessary. Powell also hinted there could be a potential for the tapering process to end earlier than expected. The key is still the magnitude and pace of the taper which market participants will be watching closely.”
While the market is grappling with inflationary pressures and potential faster than expected tapering process, we are hit with another wave of uncertainty. Omicron is here. What does it imply? This covid variant is deem “potentially” to be more transmissible, more deadly, or better able to evade vaccine protections than the delta variant. However, scientists around the world are still looking into it and not much data are available to have determining factors. Hence, no concrete proof yet.
While this is on-going, World Health Organization (WHO) issued a steadfast warning that Omicron could potentially be more transmissible. That said, we also saw globally that countries were stepping up border restrictions in-order to curb the spread of Omicron, and it added fuel to the risk-off mood. It remains to be seen if Omicron could be worse than expected and if current vaccines still work. This will continue to be an overhang at the back of investors’ mind.
Going into the year end, with seasonality factor such as thinner liquidity in play, and various headwinds on the horizon such as supply chain bottlenecks, energy crunch, and inflationary pressures, we expect more volatility. Hence, we urge investors to adopt a more conservative approach towards the year end.
Figure 1: Delta vs Omicron (Source: New York Times)
Fixed Income Overview:
U.S Fed tapering has started in November 2021 and expected to end by middle of 2022. We anticipate FED Funds rate to be kept 0% – 0.25%, with three to four rate hikes (FOMC dots median at 1% by the end of 2023) by the end of 2023 based on the September 22nd meeting. The 10-yr US Treasury dropped to 1.44% as of07 December 2021 from 1.62% as of 23 November 2021 and is expected to be around 1.0% to 2.0% for the year of 2021.
The credit default swap (CDS)index for Asia ex-Japan Investment Grade entities rebounded to 93 as of 07 December2021 from 84 as of 23 November 2021. . Asia IG credit spread rebounded to 131as of 07December 2021 from 126 as of23 November 2021. We expect IG bonds credit spreads, except for Chinese issuers, to range bound over the coming months. Asia HY credit spread rebounded to 1197 as of 07 December 2021 from 1062 as of 23 November 2021.
We expect sentiment in the HY bond market to remain relatively muted to range despite the recent injection of capital of approximate USD 6.5 billion by various Chinese financial institutions to Huarong, aiding it to serve its debts and prevent a debt default.
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 Sichuan Languang Development, Sunshine 100 China Holdings, Fantasia Holdings, Sinic Holdings, Modern Land China. Evergrande also announced on 3 Dec 2021 that it planned to “actively engage” with offshore creditors on a restructuring plan.
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 2.5 – 3 years.
We recommend investors to stick to short dated high quality (BB Rated) High Yield bonds (ex-China)with a duration of less than 3 years and be prepared to hold the bonds to maturity. At the same time, reduce/control their exposure to highly leveraged BB-rated bonds (Greenland, RiseSun) and all B-rated Chinese real estate bonds. 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 and 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, with the expectation of rates going higher and more volatility going into year 2022, we recommend a balanced and more diversified portfolio, with short duration (less than 3 years) IG and high quality (BB rated) HY 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.
Our prudence in our strategy paid dividends as we saw markets pullback especially the Nasdaq index in past weeks. With rising inflationary pressures and the potential for Fed to taper faster than expected, we envision the continuation of higher volatility into year end. To add, we still believe the Fed will be behind the curve.
Amid the on-going U.S China geo-political tensions and potential delisting of firms from U.S exchanges, we seek to reduce portfolio volatility and will recommend investors to avoid Chinese U.S ADRs, especially those non-dual listed. For those dual listed Chinese firms, we would prefer those listed on HK exchange.
As we head into the year end, with seasonality factors such as thinner liquidity, and various headwinds on the horizon such as supply chain bottlenecks, energy crunch, and inflationary pressures, we urge investors to adopt a more conservative approach towards the year end and stay in selective blue chips.
Figure 3: 1-Yearchart comparing Nasdaq Index and Hang Seng Index (Source: Bloomberg)
Geographically, we maintain our stance being constructive on HK/Greater China vs the US in terms of valuation. Still, investors should hold more cash (at least 1/3) or hedge their portfolio and prepare for higher volatility. 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 in conservative stance. We prefer sectors such as cybersecurity, select technology, auto and green energy.
It is important that investors adopt a well-diversified and defensive portfolio, stay in selective blue chips, reduce any over-exposure towards equities. 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 07 December 2021. 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”).