Investing in quality still the best hedge against coming rate rise

Andrew Sheng says well-run companies with solid prospects should be top stock choice

PUBLISHED : Friday, 03 January, 2014, 6:11pm
UPDATED : Wednesday, 28 September, 2016, 8:44am

Now is a good time to reflect on the past and consider the future. So, how did your portfolio do last year?

The Dow Jones Industrial Average for US stocks hit 16,576, with a 26 per cent gain for the year, the best year since 1996. By comparison, the Hang Seng Index rose 3 per cent; Tokyo's Nikkei did best, soaring 57 per cent and the Malaysian Bursa ended up 10.5 per cent higher, just a tad off its record high.

On the other hand, the fastest-growing economy in the world had the worst stock performance - the Shanghai A-share index closed the year down 8 per cent . Gold fell 27 per cent, while property prices seem to have done well in the US and China. Bond prices are now extremely shaky.

What is going on? The answer has to be quantitative easing by central banks in advanced economies. The world is still flush with liquidity and since investors are unclear about what direction to invest in, they have reversed investments in commodities (such as gold), avoided bonds because of prospective rises in interest rates and essentially piled into stocks.

Individual investors like you and I tend to forget that the market is really driven today by large institutional investors, including those with computer-driven algorithms who have better information and can trade in and out faster and cheaper. It is not surprising that retail investors who have traditionally driven Asian markets have been moving to the sidelines.

Even institutional investors are not equal. Long-term fund managers like pension funds and insurance companies are by and large highly regulated. And the biggest money managers today are larger than banks. BlackRock, the largest independent fund manager, looks after nearly US$4 trillion, more than most banks in emerging markets.

There are, of course, two types of asset management - active (where the managers actively invest, according to their judgment, on your behalf) and passive (where they simply follow the market indices or buy exchange-traded funds that track market indices).

According to a study of top 500 global asset managers, during the past decade, passive managers did better than the group as a whole.

So should we trust the market experts? For years, I have read Byron Wien's annual predictions for 10 Surprises of the Year. Wien was a top investment pundit for Morgan Stanley but now works for Blackstone. He defines a "surprise" as "an investment-influencing event that most money managers would only assign a one-out-of-three chance of happening but which I believe is 'probable', meaning the event has a better than 50 per cent chance". He got seven out of 10 wrong in 2013, the more relevant miscalls being the price of gold, a possible drop in S&P 500, the price of oil and the A-share index.

Bill Gross, a top bond fund manager, pointed out that retail investors tend to be conservative, while institutional investors have gravitated into more unconventional assets. Unfortunately, all these assets are "based on artificially low interest rates". So if low-interest- rate policies are reversed, investors have to be prepared.

He rightly pointed out that central banks in advanced economies are "basically telling investors they have no alternative but to invest in riskier assets or to lever high-quality assets". But if they wind down the asset buying, then higher interest rates will cause a reversal of investment prices and also cause deleveraging.

In other words, in order to keep the advanced economies afloat, their central banks are asking global investors to bear quite a lot of the risks of the downside. The smart money might be able to get out fast enough, but most retail investors do not have the skill to time their investments right.

So what should the retail investor do? Peter Churchouse, who writes one of the best reports in Asia, the Asia Hard Assets Report, quoted his son's advice as: "Buy good companies with strong earnings, strong growth and rock-solid management. The world will go on."

Quite right. But how do we know which companies these are? My answer is: watch not what the annual report says but look at what the management does.

There is, of course, no substitute for solid research of your own. The consumer or tourist is still the best investor because seeing and experiencing for yourself gives you a feeling of what is right or wrong.

My favourite economy in Asia right now has to be Indonesia. I spent nearly 10 days over Christmas going through the markets of the most densely populated cities in Java and my conclusion was that Indonesia is on the move - literally.

The population is young, mobile and connected. Every other shop seems to be selling mobile phones, cars or motorbikes. The quality of the shops, design and service has been improving.

My bet for 2014 is, if we stick to the better-run companies in the stronger economies, we should be better prepared for any "tapering" to come.

Andrew Sheng is president of the Fung Global Institute