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July 7, 2016

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Risk-on, risk-off: the ‘fragile equilibrium’

BILL MALDONADO, chief investment officer for the Asia-Pacific at  HSBC Global Asset Management, predicts the global economy will remain stuck in a “fragile equilibrium,” which does not bode well for investors.

“The main forces in the global economy — inflation, growth and interest rates — are all very low but in balance,” he said. “We don’t think things are going to change materially this year or even into next year. That means global returns are going to be very modest. So investors shouldn’t expect big returns from either equity or fixed-income assets.”

Maldonado suggested investors allocate their portfolios away from government bonds, which are vulnerable to any pickup in inflation, growth and interest rates, and move toward risk assets, particularly Asian equities and bonds.

During a recent trip in Shanghai, he shared his market views with Shanghai Daily.

Q: Investors lowered their risk appetite, especially after the Brexit vote. But you just said that we should move away from government bonds to more risky assets. Why is that?

A: We have risk-on times and risk-off times in the market. In the last few years, we got very used to risk-off events. We’ve just experienced a risk-off event because of the Brexit referendum in the UK. But it’s precisely at risk-off times that assets get very cheap, especially those outside developed markets. As long-term investors, we can try to take advantage of this risk-off moment to find some attractively valued securities. I think now is such a time. But you have to be careful. We are living in very volatile times. You can’t move all of your assets into risk assets, but you can overweight risk assets.

Q: Can you elaborate more on your opinion about China’s A-share market?

A: I think the A-share market is very attractively valued. It’s one of the cheapest markets in the region. In general, assets in North Asia, including the Chinese mainland, Hong Kong, Taiwan and Korea, are cheaper, given their level of profitability, than the ASEAN countries.

There are many sectors in the A-share market that cannot be represented well in the H share market, particularly in technology and small caps. So we remain very interested and committed to A shares.

I think it’s a good time to be a stock picker. We believe that a fundamental approach works very well in China. People think of China as a very momentum-driven market, a very non-fundamental market. But actually, we find the opposite to be true. We find valuation discipline works very well in China.

Q: Foreign investors now have different access points to China’s equity market, including quota systems and the Shanghai-Hong Kong stock link program. What is HSBC’s strategy in using different systems?

A: At the moment, we are using all the accesses. We think the QFII (Qualified Foreign Institutional Investor) and RQFII (Renminbi Qualified Foreign Institutional Investor) mechanisms give us certainty that we can access any stock at any time. So that’s kind of a one-tap access to China for core allocation. It’s less certain that you can use the connect mechanism. So far, it has been pretty easy because the quota of the stock-connect hasn’t been fully used up. But it’s getting more and more used. So we think of the connect as a kind of a tactical access. We use that to top up the amount of QFII and RQFII quotas we have. We use all the different accesses, including American Depositary Receipts and Global Depositary Receipts, which are now included in MSCI indices.

Q: You’re confident about high-yield bond markets in Asian. But there are growing concerns about Chinese debt levels. How do foreign investors view China’s bond market?

A: The Chinese bond market is very large and it’s massively under-owned by international investors. For us, there has to be a rebalancing at some point, although it has its dangers like any asset market in the world.

If we talk just about the government bond market, China’s is about the same size as France’s. The Chinese economy is growing at 6 to 7 percent, while France is growing at zero percent. There are 1.3 billion people in China, compared with around 60 million in France. So which risk would you rather take?

I’d choose Chinese risk over French risk. I’m not just picking on the French. I could say that about any European country. So I think there’s going to be a big shift of investors away from European bond markets and Treasuries and into Asia — and China in particular. That includes government and corporate bonds.

Within any market, the high-yield sector is always more risky than the investment grade and government bond sectors. Is the Chinese high-yield sector especially risky? We would say no. Last year, for example, we had a big scare about property developers, and property bond yields got very high. Then it turned out concerns were overdone and there’s wasn’t the systematic problem that many people thought. Then we had a big rally in property bonds. So there are always opportunities even when sectors look dangerous.


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