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As with their global counterparts, the search for yield persists among Asian investors. But the unfamiliar combination of rising interest rates and still muted growth is posing a challenge – not least to the region’s 5.1 million high net worth individuals (HNWIs).
HNWIs in Asia have long been known for their high return expectations, strong home bias and preference for making their own investment decisions, be that asset allocation or security selection. Yet low yields alongside rising rates are forcing them to find new means of capturing attractive income returns. At the same time, other developments in global markets as well as within Asia’s private banking industry are likely to make them less self-reliant in the future, which may provide opportunities for wealth and asset managers.
In partnership with Aberdeen Asset Management, Asian Private Banker recently hosted a roundtable featuring leading gatekeepers in the region from UBS Wealth Management, Credit Suisse and DBS Private Bank to discuss the state of income investing among Asia’s HNWIs.
Asia’s search for yield intensifies
Asia’s search for yield is hardly new. The lengthy post-crisis period of monetary easing, moderate growth and the expansion of both global and regional debt markets has made income investing a theme everywhere.
In Asia, the desire for predictable offshore income has been intensified by limited investor liquidity owing to capital account restrictions and wealth being locked in core businesses. A tumultuous 2015 and 2016 for both global and regional equities also dented the appetite for capital appreciation (PE being a lone exception) and boosted the share of income-generating assets, while a recovery for equities this year has not been sufficient to stimulate hunger to past levels.
Members of the roundtable unanimously agreed that fixed income allocations, alongside cash, have been growing as a result of investors having switched out of equities. Case in point: private banks consistently rank highly as buyers into Singapore’s local bond market. Demand peaked in 2014 when private banks accounted for nearly 44% of SGD bond issuances, before moderating to 27% the year after.
“In Asia, the income theme continues to be of interest across the wealth market,” commented John Ng, head of portfolio counselling and product strategy at DBS. “Our clients are still happy to invest on a leveraged basis in direct fixed income, or equity income, to pick up yield.”
The focus on income generation by Asia’s HNWIs is best illustrated by inflows into managed solutions of a multi-asset nature. One third of respondents in a recent Asia Private Banker DPM (discretionary portfolio management) report cited multi-asset income mandates as the most popular mandate.
Roundtable participants observed that multi-asset income funds continue to be popular – unlike pure multi-asset funds, which have experienced virtually no success. According to them, clients are less enticed by multi-asset diversification than they are by the income factor.
Income demand drives diversification and delegation
In their search for sound and diversified risk-adjusted income, private banking clients are increasingly adopting managed solutions, be it direct funds or DPM solutions. According to Asian Private Banker data, fund and DPM penetration in Asia rose to 11% and 8%, respectively, in 2016.
Although roundtable participants noted that the trend of direct bond investing by Asian HNWIs is likely to be sustained, the growth of the overall allocation may be expected to benefit other fixed income markets and managed investment solutions. Behind this movement is not just a general concern about rising rates and, until recently, a strengthening dollar, but also a recent spate of SGD credit losses driven primarily by volatile energy prices. Thus, there is a push to diversify.
“Within Asian bonds, many of our Asian clients continue to buy single bond issuers that they are familiar with, rather than investing through active managers,” said Jansen Phee, Head, Content Management, APAC, Investment Management, UBS Wealth Management, noting that Chinese developer or bank bonds are popular client-directed picks. “But in less familiar fixed income markets, they are more likely to outsource to a manager.”
One example of this is the emergence of fixed maturity bond (FMB) funds. In mid-2016, Credit Suisse successfully distributed US$2 billion worth of FMB funds to private banking clients in Asia, demonstrating regional investors’ preference for buy-and-hold strategies while delegating security selection duties. The trend has continued this year, with Bank of Singapore having raised more than US$2.2 billion worth of senior loan FMB funds after investors expressed fears of inflation risk.
A handful of other distributors in the industry have sought to capitalise on FMB demand, including BNP ParibasWealth Management, which went as far as implementing the strategy through its discretionary portfolio management (DPM) business in a 25-bond, 5-year portfolio that targets a 4% gross yield.
Meanwhile, diversified income investing is not limited to fixed income. In addition to the success of multi-asset income solutions, which have enabled private banks to increase client exposure to riskier assets and reduce concentration risk in bonds, investors have been selectively investing in other sources, such as US dividends, REITs or even direct real estate.
Irene Goh, Aberdeen’s Asia Pacific head of multi-asset solutions, finds growing diversification opportunities in non-traditional asset classes, alongside equities and bonds, such as infrastructure, where correlations are low, as well as in the likes of insurance-linked securities, aircraft leasing and peer-to-peer lending, which she accesses through liquid closed-end funds.
A greater willingness to delegate decision-making may be worth celebrating given the strong bias among Asians towards transactional investing, whether self-directed or advisory. If sustained, this may lower portfolio exposure to market timing risk and help private banks to lessen the risk of choppy revenues closely tied to market beta.
What makes Asia different? Demand for high absolute yield
In the world of long-only funds, there are four scenarios for end-clients to consider when assessing performance over any time period: a positive benchmark with positive alpha; a positive benchmark with negative alpha; a negative benchmark with positive alpha; and a negative benchmark with negative alpha.
In practice – and this is especially true in Asia – clients are satisfied only in the first scenario, roundtable participants pointed out, expressing sympathy for asset managers who are expected to deliver alpha as well as high absolute returns.
Might this change? The rise in so-called “benchmark-agnostic” returns reflects a collapse in absolute returns broadly. Whereas double-digit returns were once common, the 5.9% per year expected from multi-asset discretionary mandates (according to Asian Private Banker data) is indicative of today’s reduced expectations. Even then, Asian investors continue to demand better returns, regardless of benchmark performance.
In consequence, investors and their managers are venturing into riskier income-generating assets, including those in emerging or even frontier markets. Goh notes that these asset classes would be off-limits to most Europeans, who tend to be conservative and have a low risk appetite. Asians, on the other hand, “seek more high-octane returns, particularly in the form of income, which could potentially lead to riskier behaviour”.
It is an open question whether investors are being rewarded today for the risks associated with high yield bonds. Yield curves have flattened and credit spreads have collapsed – and are at historical lows for Euro high yield, for example. Aberdeen still sees opportunities in Emerging Market debt, noting the recent outperformance of local currency bonds given a weakening dollar and diminishing interest rate risks. It cites non-benchmark India, where the 10-year sovereign is yielding about 6.5%, the policy rate is 6%, the target 4% – and inflation is just 2.5%.
The aforementioned four scenarios, which presuppose outperforming managers in positive markets will attract flows in the region, do not always apply. At lower yield levels, such as for cash alternatives like money market solutions, investors in Asia have shown limited interest. This has less to do with yield levels relative to deposit rates and more to do with the gap with potential opportunities elsewhere.
“We have no problems with net new asset inflows; the main challenge is getting clients to appreciate that keeping their liquid assets in cash is not always the best course,” said Phee. “While investors in mature markets like Europe may opt for money market solutions in place of cash, interest in Asia for cash-plus solutions is low due in part to the kinds of major currencies our clients hold and the relative yield levels available from associated investment products.”
In deep discussion, Jansen Phee, Head, Funds Content Management, APAC, Investment Management, UBS Wealth Management; Richard Otsuki, Deputy Editor & Head of IPS Coverage, Asian Private Banker; Rodolphe Larque, Head of Funds and ETFs, Asia Pacific, Credit Suisse
Accordingly, roundtable participants affirmed the success of lower-yielding solutions such as FX or credit-linked structured products with principal protection and 2-4% upside, mirroring the cash protection characteristics of money markets but with potentially higher yields.
After more than 30 years of sustained monetary easing, led by the Federal Reserve whose funding rate peaked in March 1980 at 20%, global markets are entering uncharted territory. As central banks worldwide begin tightening, investors may have to get used to asset prices unsupported by cheap money, and the potential for renewed volatility.
Further complication comes with the erosion of the dollar’s dominance. Structural changes to the global economy are giving rise to new correlations with (and across) emerging markets. Even so, Asia’s search for yield is set to continue. The same goes for HNWI demand for income, especially if equity returns are not sustained or the global recovery stalls.
Providers would do well to capitalise on a segment worth US$17 trillion by avoiding generic products that are not tailored to clients’ needs. Asset managers that are able to combine their global capabilities with local know-how will be best positioned. Meanwhile, Asia’s private banking market continues to undergo rapid transformation in the shape of investor demographics, needs and behaviour.
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This is a sponsored advertorial from Aberdeen Asset Management.