The specialist Asian investment house describes how it has been positioning to handle market volatility and what sort of opportunities it sees emerging in the region's fixed income market.

One of the larger Asia-based asset management houses, Eastspring Investments ($125 billion of client money), is, like many of its peers, working out how best it can position itself at a time of uncertainty around China’s economy. There are concerns about just how fragile China’s still-young financial system is, as the country continues to switch towards being more of a service-based economy. This publication recently interviewed David Lai, who is an investment director at the firm’s fixed income team and based in Singapore. Lai is an emerging markets specialist but his role requires him to examine a whole range of markets.

Since the market sell-offs in January, how has Eastspring changed, if at all, its asset allocations on Chinese assets in broad terms (equities, bonds, cash, alternatives, other)?

From our fixed income team’s perspective, we view that the market rout in January was a result of a sharp retrenchment in investor sentiment globally but the macroeconomic headwinds behind this shift in sentiment, however, were not entirely new; sustained declines in oil prices, as well as concerns over growth in China and uncertainty surrounding the direction of the renminbi, are headwinds that have been playing out over the past year. More importantly, we view that there are mitigating factors which should help China avoid a hard landing scenario and which are often overlooked by the market. Firstly, we do not expect a collapse in external demand with the US and eurozone recovery appearing intact.

Domestically, China’s services sector, which accounts for around half of the country’s GDP, remains resilient, while retail sales continue to grow at a double-digit pace on a year-on-year basis. Additionally, the closely-managed nature of its economy and the relatively sound economic fundamentals (e.g. strong FX reserves, high level of savings, adequately capitalised banks) continue to provide room for manoeuvre by policymakers to stabilise markets or to boost growth, where needed.

Given this view, we have not made significant adjustments to our overall allocation to the China US dollar credit market following the market sell-off in January. It is also worth noting that in spite of the volatile external environment this year, performance of Chinese dollar credits has been relatively resilient with an overall positive gain on a year-to-date basis.

What is Eastspring's position on mainland China/Hong Kong-based debt and credit in terms of weightings, tactical views?
Our positions in Chinese debt or credits are held mainly in our regional Asian credit funds. For our flagship Asian Bond Fund, which invests predominantly in dollar-denominated bonds, our exposure to Chinese credits is around 38 per cent (as at end February 2016), which translates to a slight underweight position relative to the benchmark weight. 
     
While we hold a relatively sanguine view on the Chinese economy, we recognise that credit cycle has turned more negative due to the slowing economy and excess capacity build-up in a number of industries. In such environment, idiosyncratic risks are likely to rise and credit differentiation will be increasingly important as performance across the Chinese credit market could be more uneven going forth. As such, our portfolio positions in Chinese credits are driven more by our bottom-up views rather than top-down sectoral/country views. For example, while we maintain our view that oil prices are likely to remain weak, we continue to hold overweight positions in selected Chinese oil and gas names which benefit from strong government support (due to the companies’ strategic importance) and which have significant downstream operations where the higher profit margins provide some buffer to the weakness in upstream activities.  

Moreover, although we maintain an overall overweight in the Chinese property sector in line with our stable outlook on the property sector, we are more cautious of adding high yield property names at current valuations. The more cautious stance in the Chinese high yield property sector is premised on our view that valuations are less attractive, thereby providing less risk buffer during bouts of risk aversion.

When is the last time the firm changed its asset allocations significantly?

Our positions are managed dynamically and may be adjusted as and when our investment views change, be it on a top-down or bottom-up level. For example, for our flagship Asian Bond Fund, we increased the cash balance to a relatively high level of around 10 per cent in the middle of last year as we viewed valuations to be less attractive and that the macroeconomic headwinds then could lead to bouts of risk aversion. 
 
What is the firm's view of negative real interest rates in Japan and the impact this could have on currencies such as the renminbi, or other?

We view that the unconventional monetary policy decision underlines the central bank’s resolve to do whatever it takes to keep deflationary pressures at bay. However, the efficacy of such measure remains debatable, as corroborated by the market reaction which saw yen appreciating significantly following the policy announcement. There is also limited room for Bank of Japan to press on further on this monetary policy route without risking the stability of financial institutions in the longer term.

Nevertheless, if the ECB’s experience is a guide, the negative interest rate environment in Japan could stay for a while. This could drive a search for yields as banks are forced to lend or invest rather than keep cash in deposits. While the quantum and pace of such portfolio flows are hard to predict, we expect a gradual increase in funds flowing out of Japan to markets with solid fundamentals and decent yields, and ex-Japan Asia is hence expected to be one of the beneficiaries.