Summer 2015

CUSTODY PANEL: Asking the institutions

We quizzed two asset managers about dealing with Asian institutional investors, and asked one investment strategist if institutions should worry about investment in China. TINO MOORREES – HEAD OF ASIA CROSS-BORDER SALES, BNP PARIBAS INVESTMENT PARTNERS Do Asian institutional investors have a preference for local or global asset managers or does it depend on the asset class or strategy?
Asian institutions tend to favour global asset managers, given that they are well resourced in terms of their scope of product and capabilities compared to their local counterparts. In terms of risk management and operational platforms, global managers tend to be more progressive and advanced, hence giving them a further competitive edge. I would further point out that global asset managers, in general, are well-researched by global consultants, whereas local asset managers likely have less exposure in that regard. However, Asian institutional investors also lean towards local managers for investment opportunities in domestic equities and fixed income. To counter this, more global managers have expanded their presence, for instance through local joint ventures. For BNP Paribas Investment Partners, our joint ventures in China (HFT Investment Management) and Korea (Shinhan BNP Paribas Asset Management) have put us in good standing among investors who are looking to extend or deepen their involvement in local Chinese and Korean investments. Do Asian institutional investors differ in their outlook, strategy or temperament from institutional investors in Europe or the US?
It is often said that Asian institutions have a shorter time horizon than European and US investors. This may be cultural, or due to other constraints which could potentially impact their risk tolerance. Diversification, especially into non-traditional asset classes, is less common in Asia, perhaps due, in general, to a higher yielding environment compared to Europe and the US. Western institutional investors are usually more transparent than their Asian counterparts, a difference that may reflect the governance cultures in Asian societies. Many Asian institutions can be quite demanding on return expectations and are generally hard negotiators on management fees. Decision-making typically takes longer with Asian institutional investors, as it tends to involve more hierarchical stakeholders and less delegation to their subordinates. How have Asian institutional investors evolved in the past decade and what will happen in the next 10 years?
A notable change is the size and relative power of Asian sovereign wealth funds, which are starting to have an impact on private property and infrastructure deals. Insurance companies are becoming more sophisticated and are investing more in international assets. Insurers need to find creative ways to deal with new regulatory constraints, for instance by increasing their diversification. Central banks are also becoming more adventurous. Renminbi exposure is something they all take an interest in. Over the next few years, we expect increased volatility, especially with fixed income. Institutional investors have already anticipated this and demonstrated increased interest in alternatives. Overall, there is more willingness to accept newer investment ideas and this comes with an increasing demand for knowledge from external asset managers to educate internal investment and risk teams. DAISY HO – HEAD OF INSTITUTIONAL BUSINESS, ASIA EX JAPAN, FIDELITY WORLDWIDE INVESTMENT What are the needs of Asian institutional investors and how are these needs changing?
Institutional investors in Asia are increasingly seeking more customised solutions for their investment needs. As the value of their assets grows, they are looking for greater portfolio diversification and new investment strategies. Successful fund managers will be able to offer bespoke solutions. Over the past decade, we have seen a significant change in Asia in that institutional investors are shifting their portfolio focus further away from their respective home country bias. While some insurance and pension clients need to have a higher exposure to Asia to match their local liabilities, others are increasingly looking further afield in a bid to diversify their portfolios. Their aim is no longer to simply outperform a static benchmark, but to achieve a desirable longer-term outcome such as a defined return target or a desired level of risk, drawdowns, volatility or income generation. How can asset managers best serve Asian institutional investors?
The key in addressing these needs ultimately comes down to having an in-depth understanding of our clients’ investment profile and their respective investment requirements. With local professionals on the ground in Beijing, Taipei, Hong Kong, Seoul and Singapore, we are able to get to know our customers in a way that enables us to truly deliver a bespoke, or customised, solution. We also have a dedicated function in our Fidelity Solutions unit, with 24 investment professionals whose role is to design and manage client-specific, multi-asset investment solutions, from strategic and tactical asset allocation, to strategy selection.  Customisation does not only take place at an overall strategic level for our Asian institutional clients based on geography, but it also takes place within asset classes. Our solutions-based portfolios deploy a range of instruments including active, passive and smart beta. In fact, we have seen an increase in appetite among Asian clients to look to new strategies and non-traditional asset classes to enhance their risk-adjusted returns and income. They are also looking to mitigate concentration risk by introducing new managers, creating significant opportunities for the industry as a whole. Asian institutional investors see professional investment capabilities and consistent investment philosophy as two of the more important factors when selecting a manager. How have Asian institutional investors evolved in the past decade and what will happen in the next 10 years?
In line with their peers around the world, Asian institutional investors are increasingly also seeing the value of global network and track record. At Fidelity, we have been managing assets in Asia for over 45 years and have one of the largest buy-side global research networks in the industry, with more than 400 investment professionals located in major financial centres around the world.  Asian institutional investor needs are quickly evolving and as a result, so too is the need for fund managers to deliver more customised and innovative solutions to deliver long-term results. ANDY ROTHMAN – INVESTMENT STRATEGIST, MATTHEWS ASIA Should institutional investors in Asia be concerned about a potential financial crisis in China?
China suffers from a serious case of ‘debt disease’, but the treatment and side effects may not be as severe as some expect, and dramatic credit tightening is very unlikely. Debt is concentrated among state-owned firms, while the private firms that generate most of China’s new jobs and investment have already deleveraged. The biggest risk is the high level of debt among real estate developers. There is no question that debt levels in China rose sharply after the global financial crisis that began in 2008. A recent study by the McKinsey Global Institute says that from 2007 to 2014, China’s total debt, including debt of the financial sector, nearly quadrupled to $28.2 trillion, equivalent to 282% of GDP. The main driver of the rise in debt has been borrowing by non-financial corporations, and at 125% of GDP, “China now has one of the highest levels of corporate debt in the world,” according to the McKinsey study. Despite that, economists at the International Monetary Fund (IMF) report that, “on average, Chinese firms’ leverage is not high”. The diagnosis is that the disease is highly concentrated, presenting two distinct hotspots: state-owned enterprises (SOEs) and real estate developers. What caused state-owned enterprises to take on so much debt?
The build-up in SOE debt has been policy-driven leveraging. But the other side of the coin is that privately owned small and medium-sized enterprises (SMEs) are the engine of China’s economic growth, accounting for more than 80% of employment and almost all new job creation, as well as most investment. With the IMF estimating that median leverage for private firms fell to 55% in 2013 from about 125% in 2006, China’s most important companies are less afflicted by debt disease. The banking system is increasingly directing credit away from SOEs and toward entrepreneurs. In 2013, the latest data available, only 29% of loans outstanding were to SOEs, down from 41% in 2006, while the share of loans outstanding to private firms rose to 43% from 36%. The medicine for this problem will be another round of serious SOE reform – including closing the least efficient, dirtiest and most indebted state firms in sectors such as steel and cement – rather than broad deleveraging, leaving healthier, private SMEs with room to grow. In contrast to the experience in the West after the global financial crisis, cleaning up China’s debt problem should actually improve access to capital for the SMEs that drive growth in jobs and wealth. What are the main indicators institutional investors should watch for in the Chinese economy?
With McKinsey estimating that about 45% of China’s non-financial sector debt is directly or indirectly related to real estate, the biggest risk to debt disease turning fatal is the residential property sector.  The IMF working paper notes that “across industries, most of the build-up in leverage was in the real estate and construction sector”. But, here too, the problem is highly concentrated, as “only about 60 firms with high-leverage ratios account for more than two-thirds of the sector’s liabilities in 2013, a rise of nearly three times over the decade”. ©2015 funds global asia

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