The heat has been on with central banks around the world trying to keep inflation under control. We have seen three consecutive rate rises by the RBA, the most numerous since 2010. We have observed similar monetary policy tightening action in other jurisdictions, notably the US where the last inflation read was 8.6%. Central banks are walking a tightrope as they try to manage inflation while at the same time trying to avoid a material economic slowdown.

One of the challenges is that many of the inflationary pressures we have observed have been driven by supply side issues caused by the pandemic and the subsequent pressure on supply chains. This has been coupled with the war in Ukraine which together have driven up the price of everything from building materials, food and energy costs.

There are some initial signs however that the heat may be coming off some of the areas that have been driving inflation. Globally, there is evidence weaker demand is coming through reflected in weaker PMI figures, opening up some spare capacity and allowing supply conditions to improve. Notably, indicators such as Global Manufacturing PMI supplier delivery times are showing signs of improvement, suggesting goods are beginning to move again and the S&P Global Supply Side Shortages Indicator is easing.

Other signs of the heat coming out of the economy are evident. The most visible and arguably high-profile, given many of us have exposure, is the housing sector. The Australian housing market is showing signs of softening with auction clearance rates at two-year lows according to CoreLogic data. Sydney has recorded the sharpest fall in house prices, falling by 1.6% in June. We have also seen a string of construction companies go into liquidation, the most recent being Langford Jones Homes in Victoria.

It is too early to assess whether rate rises are having their intended effect and whether central banks have the balance right between managing demand and keeping the economy growing. However, there are signs that demand is weakening and that supply chains are slowly working through the ‘covid’ backlog. If we see sustained evidence that inflation has peaked, and bond yields show signs of stability it is plausible that central banks will pause their tightening cycle and we may even see rates come back down next year. Until that time expect more bouts of market volatility as the market attempts to price in expectations on interest rates.

Considering this environment, we have sought to moderate any material asset allocation tilts and well as factor exposures within our suite of portfolios. We are likely to hold this position until we see sustained signs of inflation peaking and rate hiking cycle approach its climax. At that point we will reassess our portfolios positioning.


IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2022 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

Equity markets ended the financial year on a negative note in June, with the S&P/ASX 200 falling around 9% to finish the quarter down 12%. This drove the ASX 200 index as a whole down 6.5% for FY22. Global equities also fell significantly over the quarter, but Australian investors received some protection on unhedged investments from a 6 cent (8%) depreciation in the Australian Dollar. Rising inflation and subsequent rising interest rates were the main factors causing these negative returns.

Dan Moradi, Portfolio Manager for Listed Products, explains in detail what caused these negative returns and provides an update on the portfolios’ latest performance, positioning and outlook.


The information in this video is prepared by Lonsec Investment Solutions Pty Ltd ABN 95 608 837 583 (LIS, we, us, our), a Corporate Authorised Representative (CAR) No. 1236821 of Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL No. 421445 (Lonsec Research). Any express or implied rating or advice presented in this video is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision you must consider your financial circumstances or seek personal financial advice on its appropriateness. Read the Product Disclosure Statement for each financial product before making any decision about whether to acquire a financial product.

Past performance is not a reliable indicator of future performance. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this video, which is drawn from information not verified by LIS. This video may also contain third party material that is subject to copyright. To the extent that copyright subsists in a third party it remains with the original owner and permission may be required to reuse the material.

The information contained in this video is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. This video is not intended for use by a retail client or a member of the public and should not be used or relied upon by any other person. This video is not to be distributed without the consent of LIS. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this video or any loss or damage suffered by the reader or any other person as a consequence of relying upon it. Copyright © 2022 Lonsec Investment Solutions Pty Ltd.

You may not reproduce, transmit, disseminate, sell or publish this video without our written consent.

Market volatility has persisted as markets are continuously recalibrating to price in forward looking inflation and the subsequent impact on interest rates and economic growth. We believe that this market volatility will persist until there is evidence that inflation has peaked and bond yields have stabilised. Bond yields have been rising, with US 10 year treasuries trading above the 3% mark and Australian 10 year bond trading above 4% in mid-June 2022 and we expect yield volatility to continue of over the next six months.

With interest rates rising, there has been increased attention on the risk of recession. The risk of recession has increased as central banks tread the fine line between trying to curb inflation and trying not to strangle economic growth. To date, economic growth remains positive, but some of the cyclical indicators are softening, indicating that the global economy is slowing. The main issue for the central banks is that monetary policy is a very blunt tool and while raising rates will most certainly curb demand, it will do little to address the supply side issues global economies are facing as supply chains remain stressed by the pandemic. A good example is China where the hard stance on Covid lockdowns have essentially brought Chinese ports to a standstill. Additionally, the war in Ukraine has driven commodity prices up including crude oil and agricultural products such as wheat, fertilizer and canola oil. Ukraine and Russia combined contribute 12% of the world’s total calories and are key suppliers of grains to Africa and the middle east. Therefore, whether we head into a recession will be dependent on the two key factors of easing of supply chain issues and central banks not overplaying their cards by raising rates too high. At this stage, our base case for Australia is that we will avoid a recession and if we do go into recession, it will not be a deep recession.

However, it is not all bad news when it comes to recessions and markets. The relationship between market returns and economic growth is inconsistent, meaning that low economic growth does not always mean low market returns and vice versa. Historically, markets have tended to lead the economy which is what we are seeing now as markets seek to price in where interest rates will go to. We have already seen markets fall around 20% as they try to price in inflation and implications on economic growth. Markets have historically recovered strongly from recessionary environments and downmarkets have tended to be short and sharp, followed by a strong rebound.

Markets are likely to be choppy over the coming six months as they try to digest inflation and the magnitude of any future rate rises. For the Lonsec Managed Portfolios, it is time to hold the line and not make big directional plays. The easy money from active asset allocation has been made and our overweight to growth assets and underweight to fixed income has served us well over recent years. However given the change in environment, we believe a more neutral asset allocation position is warranted. Despite the pull back in markets, prices are generally not in the cheap range, with the exception of emerging markets with growth continuing to be impacted by China’s covid zero policy. While bonds have been highly volatile, and no doubt have caused investors grief, there is a bright side with yields approaching levels where bonds start to look attractive. From an investment perspective, we also believe it is prudent not to be over exposed to one part of the market. Over recent years high growth stocks such as tech companies have performed extremely well, however in the coming months, having a blend of growth stocks coupled with strong cash generative quality companies will be important.


IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2022 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

With a huge array of government initiatives reshaping super in recent years, none was more keenly watched than the inaugural performance test of 80 MySuper products.

The regulator found that 13 of the 80 products assessed were deemed to have underperformed the benchmark by more than 50 basis points. Since August when the results were released, 77% of these providers have announced their intentions to either merge or exit the industry.

This year, we expect to see the second round of MySuper results likely causing some MySuper solutions to be prevented from accepting new members. This will be accompanied by the first assessment of Choice options under the test. SuperRatings has conducted analysis of the industry’s performance to 31 March 2022, using its newly developed Performance Test iQ tool. Analysis was completed on over 650 options across Trustee Directed Products, including Retail, Industry, Corporate, and Government funds, excluding MySuper products.

The results from our analysis suggest that approximately 20% of options were estimated to fail the test, which allows for annualised underperformance of the benchmark of up to 50 basis points.

Option Type % Estimated to Fail
Capital Stable (20-40) 25%
Conservative Balanced (41-59) 20%
Balanced (60-76) 17%
Growth (77-90) 16%
High Growth (91-100) 26%

Breaking down the analysis further, SuperRatings found that all option types are facing challenges. In particular, options with growth assets, such as equities, making up between 91-100% of assets held were most likely to fail the test, with 26% of these options estimated as failing based on performance over the 8 years to 31 March 2022. Capital Stable options with between 20-40% growth assets are also facing a challenge to pass the test, with around a quarter of these options estimated as failing.

As the performance test captures investment returns over an eight-year period, funds have limited ability to shift their relative long-term position against the benchmark. However, with the test only accounting for the most recent level of fees charged, funds do have the ability to make fee changes to improve their performance test outcomes.

SuperRatings has been tracking an estimate of the benchmark representative administration fees and expenses (RAFE) based on the performance test calculation. While the test appears to be having an impact in terms of reducing fees for the MySuper products which were tested last year, our analysis shows that the Trustee Directed Product RAFE has remained flat.

 

We observed a decline in the RAFE for MySuper products each quarter since the start of the financial year, however the Trustee Directed Product RAFE saw an increase in the September quarter, followed by a return to the same RAFE in December 2021 and has remained stable since.

Since the results of the first test were published, we have observed an increase in funds seeking to simplify their investment menus, as well as a faster pace of merger announcements and shorter times for mergers to reach completion. While there are clear cost savings for funds in managing fewer options, the benefits of member choice are real, with highly engaged members particularly valuing additional choice. We suggest funds take a balanced approach when assessing the viability of offering additional options to ensure members achieve the best possible retirement outcomes.

The first performance test has had a significant impact on the future of those products which failed. Having an industry wide benchmark gives funds a clear target with significant potential benefit for members, however ensuring the test is appropriately capturing the nuances of the range of investment options in the industry remains a challenge. The regulator will be releasing the results of its second annual performance test later this year, with the industry closely monitoring potential outcomes. As the industry awaits the results of the second test, SuperRatings continues to use its comprehensive database and deep research capability to gain key insights into super fund performance and the future outlook for the industry.

In this video, Lukasz de Pourbaix, Executive Director and CIO of Lonsec Investment Solutions provides an update on what’s been happening in the markets, with market volatility and inflation. Lukasz then explains what this means for the Lonsec portfolios.


IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2022 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

With the passing of the government’s Retirement Income Covenant legislation, funds now have a clear framework and timeline to guide their path forwards.

As we expect the number of retirement income products in the market to grow, it is crucial for funds to ensure they are appropriately resourcing education, advice and digital capabilities to support retirees in understanding, planning and managing their retirement strategies.

Camille Schmidt, Market Insights Manager, SuperRatings

With the regulator set to release the results of its assessment of performance for Trustee Directed Products for the period to 30 June 2022, we have estimated the potential outcomes for diversified Choice options using our new Performance Test iQ analysis tool for the 8-year period to 31 March 2022.

The results indicate that approximately 20% of options were estimated to fail the test, which allows for annualised underperformance of the benchmark of up to 50 basis points.

Kirby Rappell, Executive Director, SuperRatings

After years of low inflation and low interest rates, we have finally entered a new period in the economic environment of higher inflation and higher interest rates. But how high will inflation be and by how much will interest rates rise? Periods of transition from a market perspective increase uncertainty and subsequently increase market volatility.

From a dynamic asset allocation perspective, over a number of years we have built up our exposure to real assets and have included alternative assets such as gold, as inflation risk was growing. While we have maintained an underweight exposure to fixed interest, we have ensured that our exposure to the sector has been diversified which has become increasingly important as bond yields continue to rise. The rise in bond yields will means that at some point the yields on offer will become attractive again and warrant an increase exposure. It is fair to say that we believe the coming period will be one where bottom up investment selection will be a key contributor to performance compared to the recent past which has been dominated by low interest rates and ample liquidity which supported a strategy of being long equities and short bonds, which drove performance for many strategies.

From a bottom up perspective, we have seen extreme market activity. On the equities side, the winners have been largely concentrated to those parts of the market that are expected to benefit from a higher inflation environment such as energy and resources. This market environment has seen value style managers outperform growth style managers in recent months, as any long duration investments such a growth equity stocks, which are priced for future growth, have been sold down irrespective of their quality. While the performance of growth style investments has been disappointing, we don’t think it is the time to throw the baby out with the bath water. The market has already pulled back and provided companies are supported by earnings and have solid balance sheets, a long term allocation to growth is still warranted as part of a diversified portfolio. Similarly, on the fixed interest side, bonds have sold off as bond yields have risen. Clients are rightly nervous about their portfolio bond allocation, however if we look forward, bonds are looking much more attractive now on a forward-looking basis than they have in a while.

In volatile times, when returns can look ugly, it is tempting to be reactive and want to sell the ‘losers’ however markets are forward looking and it is important to consider what is already priced into the market. Challenging times ahead but history tells us that market pull backs tend to be sharp but also generally don’t last long.


IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2022 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

A look at Chinese equity managers’ performance over 18 months to March 2022.

To say that the last several months have been difficult for the investment landscape within China would be an understatement. For the 18 months ending March 2022, the MSCI China NR Index (measured in AUD) has returned -28.7% on a cumulative basis. On a monthly basis, the Index has ended in red in 11 of the 18 monthly periods. Given China’s prominence in the Emerging markets and Asia ex Japan Indices, performance for these broader Indices (measured in AUD) also remained weak generating cumulative returns of 3.6% and -0.8% respectively. The period was marked by a series of regulatory developments, each one more extreme than the prior in terms of testing investor patience, discipline, and appetite for Chinese equities. The ‘common prosperity’ theme, a rhetoric increasingly promoted by the Chinese Communist Party (CCP) during this time, permeated strongly in all instances.

This report looks to delve into the key developments within China over the analysed period (October 2020 to March 2022), analyse the evolution of Chinese/Hong Kong stock holdings and the aggregate allocation of a majority of Lonsec’s Global and Emerging Markets equities rated universe alongside the associated performance outcomes for the period. It concludes with an outlook of the investment landscape moving forwards.

Thunder, lightning, and everything frightening!

A quick Covid-19 recovery through early and mid-2020 led the Chinese market to surpass its 2015 highs of US$10trn ($14trn). However, the euphoria quickly fizzled out as the first wave of regulatory crackdowns surfaced. After a four-month anti-monopoly probe, Chinese regulators fined Alibaba a record RMB 18bn (US$2.75bn) and suspended (eventually cancelled) the upcoming IPO of its financial arm, Ant Group to tackle a long simmering problem in the tech sector: anti-competitive practices. During this time, China enforced an antitrust guideline for the “platform economy” giving more teeth to the first major revisions made to the Antitrust Law (the second public consultation was completed in November 2021) in 13 years. A new antitrust bureau was also launched in November 2020, responsible for conducting antitrust investigations and oversight into M&A activities and market competition.

The subsequent sell-off in internet stocks, although initially short lived, signalled the start of a sharp reversal of a long-term uptrend of large cap technology companies. Throughout the year, other internet conglomerates including Tencent, Baidu, ByteDance, Meituan and Didi Chuxing were also fined for violating the anti-monopoly law resulting in significant share price corrections.

The interventions were not isolated to the technology sector however, reforms also took place in the education, online gaming and property sectors precipitated by a desire to prioritise social stability and common prosperity objectives. The education sector bore the full brunt of policy actions in July 2021 when the State Council released the ‘double reduction’ policy guidelines to address the burden of an excessively competitive academic success culture. The stipulations contained within overhauled the entire industry structure effectively transforming it into a non-profit sector overnight and resulting in a swarm of tutoring companies going bankrupt. Share prices of the three largest players New oriental education, TAL education and Gaotu techedu fell 54%, 71% and 63% respectively on the day of the announcements and have since been effectively worthless (down 92% on average for the 12-months ending April 2022).

Besides taking aim at the education sector, China’s focus on the growth and development of the next generation also spilt over to the online game industry. In August 2021, China limited the amount of time children can spend on video games to avoid gaming addiction, which may harm their academic and personal development. This had significant implications for the world’s largest online gaming market and materially impacted the fortunes of companies such as Tencent and NetEase.

Volatility returned in the last quarter of 2021, as the property sector, a key driver of economic growth, local government funding, and investment savings for a large portion of the Chinese population, succumbed to stringent policies to curb speculation and credit expansion. The latest rules included further restrictions on developer financing and home purchases, serving a significant blow to the overall industry. Additionally, China Evergrande, one of China’s biggest real estate developers, found itself in a headline-making liquidity crisis eventually defaulting on US$1.2bn of its offshore debt, followed quickly by other lower quality developers.

The flurry of negative headlines has continued well into 2022. Chinese equities have underperformed for the most part in the first quarter of the year due to several domestic and external events hitting the market simultaneously. Key factors contributing to this have been a combination of macro / policy headwinds including further regulatory reforms in key sectors, rising geopolitical tensions with the US, re-escalation of American Depository Receipts (ADR) delisting risks, surging Covid-19 cases and China’s rigid ‘zero Covid’ response plan, and more recently the Russia-Ukraine conflict which presents a real threat to global growth.

Navigating the tides…

For investment managers with significant exposure to China, the period was challenging to say the least. The table below looks at performance and portfolio allocation to China/Hong Kong for a manager peer group of 31 products across both Emerging Markets / Regional Asia and Global Equity sectors (26 and 5 respectively) between the months of October 2020 to March 2022. During the 18-month period, the peer group delivered an average cumulative return of -0.2% (median 0.3%). On a quarter end basis between September 2020 to March 2022, the region’s representation in the benchmark Indices declined meaningfully, from 46% to 42% in MSCI Asia ex Japan, from 42% to 30% in MSCI Emerging Markets, and from 6% to 4% in the MSCI AC World Indices.

In terms of performance, on a subsector basis, global large cap managers with a significant exposure to China (>10% on average) within the peer group produced the weakest outcomes; an average cumulative return of -6.2%. Regional Asia and Global Emerging Markets managers within the peer group generated an average cumulative return of -1.1% and 2.6% respectively. Relative underperformance was tilted towards managers with higher exposure to offshore listed companies in Hong Kong and US listed ADRs which fell indiscriminately during this period. By contrast, managers who held onshore China A shares delivered stronger returns on the back of many sectors doing well. Within the Regional Asia cohort, managers with exposures to large cap growth names and sectors most severely impacted by the regulations faced headwinds while managers with a greater skew towards small and mid-caps, especially those linked to the green economy and the domestication of supply chains, benefitted during this time. And finally, performance fortunes tilted towards valuation sensitive Global Emerging Markets managers who either drastically rebalanced away from consumer and technology sectors at the start of the year or were already underweight these sectors.

Nearly all products within the peer group saw a reduction in their absolute portfolio allocation to China/Hong Kong to varying degrees depending on the performance of underlying holdings and their relative investment outlook. The exceptions to this were the Lazard Global Emerging Markets and FSSA Global Emerging Markets Focus funds where the ending allocation remained fairly consistent with that at the start of the period and the Pendal Asian Share Fund which saw an increase in its allocation. Nevertheless, all three products remained underweight relative to their respective Indices during this time.

On an aggregate basis, Global Equity managers with significant exposures to China demonstrated the largest adjustment to their absolute portfolio allocation to the region, followed by their Global Emerging Markets counterparts. The Global Equity peer group maintained an average quarterly weight of 17% relative to the 5% weight in the MSCI AC World Index. However, notably towards the end of March 2022, large cap quality / GARP and quality / growth managers such as Magellan and DSM capital fully divested their portfolio holdings on account of growing political and regulatory uncertainties.

Global Emerging Markets peers maintained a mean portfolio holding of 28% relative to 36% in the Index. The biggest change in ending allocation was in GQG Partners Emerging Markets Equity and Legg Mason Martin Currie Emerging Markets funds where absolute holdings to China/Hong Kong declined from 43% to 15% and 37% to 26% respectively. During this period, the group had only a small subset of managers that remained overweight relative to the Index (between 1 and 4 at any point in time). This included Vanguard Active Emerging Markets Equity and Abrdn Standard Emerging Markets Equity funds which held a 7% and 4% relative overweight to the Index at the end of March 2022 respectively. This was backed by a positive view on high quality growth names in the region and/or the prospect of a counter cyclical recovery. The group also included the Warakirri Global Emerging Markets Fund which held a 0% weight to China and a 10-11% weight to Hong Kong (primarily a global industrials exports business, Techtronic Industries) during this time.

The Regional Asia cohort maintained a mean exposure of 45% relative to 47% in the MSCI AC Asia ex Japan Index. The biggest change in allocation was in Cooper Investors Asian Equities and Mirae Asset Asia Great Consumer Equity funds, where holdings declined from 62% to 34% and 61% to 46% respectively. Several managers in this group maintained an overweight relative to the Index during the period, ranging between 5 to 9 managers at any point in time (7 as of March 2022). This included GARP style Cooper Investors and Mirae Asset funds, value style Premium Asia and core / style neutral Schroders Asia Pacific and Fidelity Asia funds which were c. 13-16% overweight at the start of October 2020. Of these, Cooper Investors experienced the largest decline, ending the period at a -8% relative underweight, while the remaining maintained their overweight positions to varying degrees despite a reduction in absolute allocations.

The following table lists stocks that saw the largest change in their representation across the peer group’s portfolios on a quarter end basis between October 2020 to March 2022. Large cap technology names such as Alibaba and Tencent that had previously benefitted from nearly a decade of tailwinds from the consumption growth thematic, both from both global and local investors, saw a sharp decline in their portfolio representation during this time. Insurance giants AIA group and Ping An were next in line as investors wary of the growing property sector woes sold the names frantically. Also struggling were technology stock JD.Com and delivery giant Meituan who faced ongoing anti-monopoly and competitive threats. Other notable mentions included exits in the ill-fated New oriental education which succumbed to the regulatory pressures and CNOOC which was placed on an economic blacklist by the US.

Stocks that have seen increasing representation in manager portfolios include names directly benefitting from a transition to a green economy, expanding domestic consumption and those linked to the broader strategic aims of the CCP such increasing self-reliance in semi-conductor manufacturing. Notably, given currently depressed valuations and forecasts of better medium to long term returns, there has also been a renewed interest in names like Alibaba and Meituan after their tremendous fall from glory.

Smoother sails ahead?

Having battled through monumental challenges over the last several months, investors have rightly been concerned about the future of the Chinese investment landscape. Risks of ongoing covid induced lockdowns, slowing growth, further regulatory interventions, and escalating geopolitical political tensions have been at the forefront of investment discussions. Given this backdrop, the CCP’s ‘Two Sessions’ meeting last month in March has provided investors with valuable insights into the government’s plan to promote stable growth in the region. Key priorities for 2022 include a GDP growth target of 5.5% with a CPI target of around 3%. This growth target is at the higher end of the market expectations range and emphasizes the government’s pro-growth policy stance. It also highlights the significance of 2022 as a politically important year for president Xi Jinping who is poised to extend his term as party chief for a precedent-breaking third time during the CCP national congress in the latter half of this year. In saying that, Lonsec considers these short-term targets to be ambitious and critically dependent on key aspects such as easing of lockdown restrictions and a more relaxed Covid approach.

Longer term, in Lonsec’s view, the regulatory storm appears to have subsided. In March 2022, Vice Premier Liu He addressed key market concerns and called for order and transparency in dealings with big tech firms. Alibaba’s share price subsequently rebounded by 65% showing the significance of this speech. Policymakers have demonstrated an urgency to reverse the liquidity crunch currently faced by quality developers and restore consumer confidence in the property sector. Regulators have also been working with the US SEC to resolve the data requirements for Chinese companies to remain listed in the US. Finally, the government has moved to provide monetary and fiscal stimulus at a time when the rest of the world is struggling with rampant inflation which has led to an increased risk of stagflation. On the back of these announcements in April 2022, Chinese equities generated 1.4% (as measured by the MSCI China NR Index AUD) recouping some of the losses experienced during the earlier month.

Valuations in China are currently attractive with many companies trading at historically low multiples and several managers in the peer group remain optimistic on future investment prospects. As of the end of March 2022, managers in the peer group held a considerable allocation to the region (29% on average). In the months to come Lonsec expects markets risks to abate further, albeit volatility and risk premiums may remain elevated for some time. Also given the recency of regulatory developments, some parts of the market such as the internet, education, healthcare may see a lower return profile over the medium term. However, high-quality companies in China with new growth drivers such as the green economy, improved mental and physical health of the nation, and inward-focused technology replacement programmes, for example in semi-conductors are expected to grow rapidly.

Note – an abridged version of this article was originally published in The Australian newspaper on Friday, 27 May 2022. 

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Originally published in The Australian, 7 May 2022

This article presents the views of Alan Dupont and do not necessarily reflect those of Lonsec.

The ripple effects of the Russo-Ukrainian war are spreading and intensifying. Deglobalisation will jeopardise the prosperity and welfare of millions.

The ripple effects of the Russo-Ukrainian war are spreading and intensifying. Their impact is being felt in almost every corner of the globe, revealing an international system under duress.

The US-led rules-based order has survived and prospered for 77 years through numerous regional conflicts, terrorist outrages and economic shocks. But this time it’s different. Although not the sole cause, the Ukraine conflict is driving a once-in-a-century redesign of the world’s economic and geopolitical plumbing.

Like a once-proud liner battered by countless storms, the old order is in danger of listing, beset by numerous cascading external crises. The threat of nuclear war has increased and the world is rearming as security concerns grow. Food and energy spikes are jeopardising economic recovery, fuelling inflation and shaking up global supply chains already disrupted by Covid-19 and the  accelerating decoupling of the US and Chinese economies. Climate change is complicating energy choices. Trade and financial power are being weaponised. Protectionist sentiment is on the rise. All this is morphing into a system-altering super-crisis. There will be no return to normal service.

The emerging world order will be messier, less stable and more contested than the last, with neither autocratic nor democratic states in charge. The world is again beginning to divide into competing economic and geopolitical blocs, one aligned with the US, another with China, and a European grouping that will be primarily, but not wholly, in the US camp. A fourth group of developing countries may try to maintain their independence from the dominant blocs in a futile attempt to reenergise the moribund non-aligned movement. Non-alignment won’t be a viable option if larger nations continue to flex their muscles.

But the most far-reaching consequence will be the end of globalisation as we have known it. The Russo-Ukrainian war has set in motion deglobalisation forces “that could have profound and unpredictable effects”, OECD chief economist Laurence Boone says. Harvard political economist Dani Rodrik agrees. The war has “probably put a nail in the coffin of hyperglobalisation”, he says.

Peterson Institute for International Economics president Adam Posen writes in US policy journal Foreign Affairs that globalisation has been steadily corroding since its high point at the turn of the century. The reasons? Populists and nationalists “have erected barriers to free trade, investment, immigration and the spread of ideas”. China’s challenge to “the rules-based international economic system and to longstanding security arrangements in Asia has encouraged the West to erect barriers to Chinese economic integration”. Posen says the Russian invasion of Ukraine and resulting sanctions “will now make this corrosion even worse”.

So do John Micklethwait and Adrian Wooldridge in a penetrating analysis for Bloomberg News of the consequences of globalisation’s failure. They write that Chinese President Xi Jinping has spent much of his rule building a Sino-centric economic order on the back of his trillion-dollar Belt and Road Initiative that spans half the globe. The invasion will harden Xi’s determination to reduce China’s dependence on the West, fortified by the “wolf pack” of young Chinese nationalists around him. The breadth and speed of Western sanctions against Russia “is another powerful argument for self-sufficiency”.

But there is a deeper reason: the rise of geoeconomics. First coined in 1990 by American strategist Edward Luttwak to describe the willingness of states to use economic and financial power for geopolitical purposes, geoeconomics has become a preferred tool of statecraft. A recent Deutsche Bank report concludes that as great power competition becomes more pronounced, “geoeconomics is likely to be the tool of first resort in addressing international conflicts”.

The use of economic warfare to achieve geopolitical ends is not new. Trade blockades were a feature of the Napoleonic Wars. Autocratic German regimes weaponised trade policy in the first half of the 20th century to achieve global influence. Pre-World War II Germany was a “power trader”, manipulating trade for strategic and commercial advantage. In more recent times, economic statecraft has become an integral part of a distinctive Chinese approach to foreign policy in which economic and trade coercion is used to cement China’s place as a leading global power. During the past decade more than 27 countries, including Australia, have been on the receiving end of such coercion.

Much to the surprise and chagrin of China and Russia, the US has taken geoeconomics to another level using its economic and financial clout to devastating effect in support of Ukraine. About $US300bn of Russia’s $US640bn ($899bn) in gold and foreign exchange reserves have been frozen.

Once considered the “nuclear option”, the US and its allies have cut off Russia from the SWIFT international payment system and the central institutions of global finance, including the International Monetary Fund and all foreign banks. Russia also has been slapped with the most comprehensive sanctions levied against a significant economy. Unlike earlier sanctions against Iran, Venezuela and North Korea, they are being used against a major exporter of food and energy. Only the US has the financial power to make these sanctions work. But they also require an unprecedented degree of co-ordination among Western allies. “It is the alliance, not the finance, that has mattered,” says Posen. Freezing the Russian Central Bank’s reserves works only if Europe is on board.

If China invaded Taiwan, could the US opt for a hard decoupling and prevent China from accessing the 60 per cent of its $US3 trillion foreign reserves held in US dollars? This might be a bridge too far because of the reciprocal costs China could impose and the collateral damage to the US and global economies. A report last year by the US Chamber of Commerce assessed that a soft decoupling would cost the country at least $US500bn of lost gross domestic product, equating to a 2.5 per cent drop in the US economy.

Cornell University academic Nicholas Mulder, author of The Economic Weapon: The Rise of Sanctions as a Tool of Modern War, estimates a hard decoupling could collapse US GDP by 5 per cent, about $US1 trillion – a bigger shock than Covid in 2020.

Still, the speed and severity of Western sanctions stunned Chinese officials, drawing criticism. Vice Foreign Minister Le Yucheng said “globalisation should not be weaponised”, seemingly oblivious to the arbitrary economic and financial punishment his own country has meted out to other nations across the past decade. “We are shocked,” economist and former adviser to the People’s Bank of China Yu Yongding told Nikkei Asia. “We never expected the US would freeze a country’s foreign currency reserves one day. And this action has fundamentally undermined national credibility in the international monetary system. Now the question is, if the US stops playing by the rules, what can China do to guarantee the safety of its foreign assets?”

The short answer is that Beijing’s options are limited. Despite its financial heft, the yuan is not fully convertible like the US dollar or euro and accounts for only 2 per cent of global payments. Beijing could mitigate the risk by persuading BRI members to use the yuan instead of the dollar, opening the door for others to follow suit. Saudi Arabia is already considering oil sales to China that would be transacted in yuan. And Russian and Chinese officials are working to connect their countries’ financial messaging systems to circumvent the Western-controlled SWIFT. These measures aren’t likely to dethrone the US dollar in the short term, although that won’t stop China and fellow autocrats from trying.

The conclusion of financial analyst Cissy Zhou is that the global financial landscape is set to become more volatile. Sanctioned countries may choose to side with their own bloc for trading and investment. Russia has demanded that Poland and Bulgaria pay for its gas in roubles, not dollars, and has called on its fellow BRICS emerging economies (Brazil, India, China and South Africa) to extend the use of national currencies for international payments to dilute the dollar’s power. If the West continues to impose financial sanctions on the non-democratic world a dualtrack system in global finance could well emerge.

None of this is comforting. Sanctions and embargoes may be preferable to war, but the increased use of geoeconomics is bad news for globalisation. It will discourage economic integration, free trade and technological innovation, leading to lower growth, trade barriers, protectionism and a shrinking of the global economic commons. “What we’re headed toward is a more divided world economically that will mirror what is clearly a more divided world politically,” Council on Foreign Relations senior fellow Edward Alden says. “I don’t think economic integration survives a period of political disintegration.”

Despite recent bad press and widespread belief that globalisation has benefited elites at the expense of the less fortunate, economic liberalism has lifted more than a billion people out of poverty and enriched many lives. Access to goods and services, international travel, instant communications and advances in almost every field of human endeavour are some obvious benefits. World trade in manufactured goods doubled in the 1990s and doubled again in the 2000s.

A geopolitically and economically divided world could ignite another world war just as the end of the first age of globalisation culminated in World War I. Beggar-thy-neighbour tariffs and power trading more than halved international trade between 1928 and 1933, leading to the Depression and World War II. Only after 1945 did economic integration resume its advance – and then only in the Western half of the map.

“What most of us today think of as globalisation only began in the 1980s, with the arrival of Thatcherism and Reaganism, the fall of the Berlin Wall, the reintegration of China into the world economy and, in 1992, the creation of the European single market,” Micklethwait and Wooldridge write.

A reversal of globalisation will not sweep away the world we know. But it will slow progress, jeopardising the prosperity and welfare of millions of people in the developed and developing worlds. Deglobalisation will hurt Russia and curtail China’s power. Their quest to insulate themselves from sanctions by turning inward will sap the dynamism of their economies and reverse decades of progress. It won’t be good for the West either, particularly trade-dependent states such as Australia. The Western order assumes free trade and greater economic interdependence lessens the risk of war. This belief drove the Western victors of World War II to create an order that would unite victors and vanquished in a shared economic and political future.

As the second age of globalisation begins to buckle, the challenge for US President Joe Biden is to build a constituency for a new world order that preserves globalisation’s enriching features, creates wealth, bolsters the alliance, and exposes the excesses and failings of the authoritarian alternative. As an ally and significant middle power, Australia must take the lead in urging the US and like-minded countries to resist the false lure of protectionism and the fragmentation of the world into competing blocs. Avoiding this dystopian future will require a fresh narrative and strategy.

Russian President Vladimir Putin’s no-limits barbarism has had the unintended consequence of reuniting polarised democracies. This new sense of unity, Micklethwait and Wooldridge write, “is no longer confined to the metropolitan elite. One of the great problems with modern liberalism of the past few decades has been its lack of a gripping narrative and a compelling cast of heroes and villains. Globalists have talked a bloodless language of ‘comparative advantage’ and ‘nontariff barriers’, while populists have talked about sneering elites and hidden conspiracies. Now Putin has inadvertently reversed all that. Freedom is the creed of heroes such as (Ukrainian President Volodymyr) Zelensky; anti-liberalism is the creed of monsters who drop bombs on children.”

But a narrative without a strategy is like a car without an engine. The strategy should have two main purposes: hardening the resolve and ability of the Western alliance to withstand further adventurism from Putin and his authoritarian soulmates; and deepening the economic integration of like-minded countries through an inclusive reglobalisation. This should leave no one behind and the door open to autocracies. But only if they are prepared to respect the rules of an international order from which they have gained enormously.

Although Biden has exceeded expectations in rebuilding the alliance and coaxing Europeans to take more responsibility for their own security, he has failed to bind economically America’s European and Asian allies with cross-regional trade deals. A central aim of our foreign and trade policy should be to persuade Biden to advocate for free trade by committing his country to high-standard free trade deals that offer tangible benefits to vacillating non-democracies as well as the developed West. Joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership linked to a redesigned Transatlantic Trade and Investment Partnership would be a good start.

As Micklethwait and Wooldridge observe, the US “won the last Cold War peacefully because it united the free world behind it. This is the way to win the next one peacefully as well. Put together the free world’s economic potential – the EU, North America, Latin America’s biggest economies and the democracies of Asia – and it can do more than see off the autocracies; it can pull them towards freedom.”

There is no more important task for the next government than persuading the Biden administration to advocate for an inclusive reglobalisation. Re-designing economic liberalism to make it more sustainable, egalitarian and interconnected is the best way of reversing the worrying descent into war, conflict and division.

Alan Dupont is chief executive of geopolitical risk consultancy The Cognoscenti Group and a Lowy Institute nonresident fellow.

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