Active Thinking

At GAM Investments’ latest Active Thinking forum, three of our brightest investment minds discussed approaches to diversification and commented on policies in China and the country’s equity market.

06 December 2021

Anthony Lawler – Systematic Macro and Alternative Risk Premia

The current environment is challenging for traditional equity and fixed income investors. On the equity side, valuations are expensive compared to history and have arguably decoupled from earnings over the past 12 months with equities rising faster than earnings expectations. Investors are also cognisant that a decade long strong bull market cannot last forever, as we know from history. In the fixed income space, yields remain at historic lows and with a risk of capital loss should rates rise from here with inflation. With this backdrop in mind, we believe adding diversification through liquid alternative strategies could be a rewarding approach for investors over the long term, as opposed to simply adding more equity or bond risk. Importantly, different diversifiers have different pay-off profiles. We think of diversification in two ways. First, diversification (ie looking for returns not simply driven by global growth and interest rate expectations as equities and bonds are) can be achieved via investing across multiple asset classes, both on the long and short side. Alternative risk premia strategies and certain insurance-linked securities markets are examples in this area of liquid alternatives. Second, there is also diversification that has a ‘positive convexity’ profile (ie the ability to capture positive performance in a sustained bear market) such as systematic macro and trend following strategies. Different diversification approaches serve different purposes and can be complementary in a portfolio. Ultimately, we believe experienced practitioners and solid research platforms are best placed to deliver results over time in the liquid alternatives space.

Jian Shi Cortesi – Asia / China Equities

Chinese and Asian equities have underperformed in 2021. Regionally, China’s policy tightening has been a big drag due to divergence from other countries where policies have remained quite accommodative. However, we expect China’s policy backdrop to improve next year and believe the government wants less economic risk ahead of the Chinese Communist Party congress in the second half of 2022, where President Xi is expected to be re-elected. Other factors influencing the region going forward include US interest rates which set the tone for the global equity market. Increasing interest rates in the US could be a major risk factor for equities globally, particularly for companies with high valuations. Another risk factor going into the next year is the Covid-19 situation which is especially important for the recovery of Southeast Asian markets.

In China, valuations are currently at the lowest point we have seen in a decade. Based on this, we believe China could start to outperform the rest of the world going forward. When China performs well, Asia tends to perform well. In the short term, investors are concerned about headlines related to Covid-19 or government policy. But over the long term, what really matters, in our view, is whether companies can continue to grow and increase profitability. As the economy grows, companies grow and that is where investment returns come from. Shorter-term noises are secondary to longer-term fundamentals. It will not be a smooth ride, however, as investor sentiment is still very fragile. Additionally, in the past we have seen performance tends to move sideways for a period after a fall before investors finally get comfortable and warm up to China again.

Wendy Chen – China Equities

It has been a difficult year for Chinese equities with regulatory shocks, geopolitical tensions, and economic stress. But China’s GDP is still on track to register 7-8% growth for the year, beating a 6% target. China’s zero-tolerance policy towards Covid-19 has forced a repeated opening and closing of businesses and resulted in a historic low for consumption expenditure growth. In addition, a crackdown on the real estate sector, which used to contribute 2-3 percentage points of GDP growth, is set to become a drag going forward. The Chinese birth rate has dropped to its lowest point in the past 43 years; the large industrial workforce is now aging and slowing. Consequently, there has been a shift in regulatory focus from speed of growth to quality of growth, eg deleveraging to minimise potential collateral risk. This shift can be seen in increasing expenditure on sustainability, with less manufacturing and labour input, giving China a potential leap forward into the global digital revolution. Additionally, a need for common prosperity has emerged, stemming from social media altering public opinion and the economic boom which has increased the world’s largest middle-class population.

The recent economic downturn has had a notable impact within advertising. Education and gaming were huge advertising areas in China, both of which have been targeted by policymakers. Involvement with the metaverse has increased. As gamer license approvals have been suspended since August, larger companies are surviving on their reservoir of business or their title while smaller companies can only pitch a metaverse story for stock market attention. E-commerce is also impacted by weak consumption sentiment, hence most of China’s internet names could potentially see margins diminishing over the next two or three quarters. The 2022 Winter Olympics in February is being held in Beijing which could see China’s strict Covid-19 policies loosened somewhat. Meanwhile, local and central elections will be important. Historically, in a re-election year, policy tends to be mild after the Chinese party congress. Re-election might prompt the government to use new methods to boost market growth, such as injecting liquidity into the real estate market and easing Covid-19 regulations.