Market Update: October 2020

Oct 6, 2020 | Articles, Global Markets Update

COVID 4 : Governments 2

September was a difficult month for equity markets as MSCI ACWI (developed and EM) dropped -3.4%. Tech stocks were particularly hard hit as the NASDAQ fell -12% from peak to trough before recovery a little to be down -5.2% for the month. Further, against the trend was the 2.1% rise in the USD Index and Gold fell -4.2%. Commodities also gave up ground with WTI oil falling -5.6% the London Metals Index fell -1.6%. One of the few places to hide was investment-grade credit which was flat for the month.

At the end of the month, just as Tech stocks appeared to be finding their feet, President Trump succumbed to the Virus, creating yet another cause for uncertainty. Along with the second COVID wave in Europe, cases in the US mid-west rising, major global economies starting to lose recovery steam, and the difficulty in passing the stimulus package in the US Congress, equity markets could remain unsettled in the short term.

Despite the likelihood that the health of the president and the upcoming US elections may hold many investors’ attention, we remain relatively sanguine for the medium term. A Biden victory appears already partially baked into prices and is generally perceived less favourably for markets than a Trump victory, but it may be pertinent that during Obama’s 8 year reign the S&P 500 Index surged 160%, an annualized return of 12.7% p.a. Not even “Reaganomics” could outperform those numbers. Yes, there is the threat of a tax-cut roll-back, but that is not a given and could be politically unpalatable in the medium term as the nation struggles to recover from the Virus. Apart from some stated policy differences concerning a few sectors, both candidates are keen to support rapid economic recovery and that could be the overriding factor for markets. In fact, the sector differences have already begun to play out some months back in Defence and Health Care with some sub-sectors at 10-year low valuations relative to the Index.

Source: Strategas Research Partners

Second Half Comeback?

Composite PMI numbers for the large economies still appears relatively resilient. But the improvement in numbers coincided with lower new COVID cases and loosening restrictions in many parts of the world. Recently, lockdown rules have been tightened in some countries such as France, Spain and the UK. More are planned if conditions to do improve with New York also planning stricter rules as cases start to climb again. Large scale vaccine treatment is expected to be ready by mid-2021, but that’s 8 months away. With the coming change of seasons, the risk of a growing infection rate and further tightening of lockdown rules cannot be discarded.

Source: Bloomberg, Odyssey

To offset these economic impediments and the potential for social unrest, governments may need to do more. This means further boosts to fiscal stimulus. The US is deliberating over a massive stimulus package. Despite the urgency, the consensus view is that it will not pass Congress before the US election. That means the market must be supported on the belief that the package will pass both houses expeditiously after the election. Any news that suggests the package may be further delayed is unlikely to meet with a positive market response. On the other hand, if taken at face value: the President’s health continues to improve, the elections proceed without abnormal scandal, and the stimulus package can be passed since the elected government should have a mandate, we can realistically look constructively at the equity market. Real-life and the markets usually do not behave so smoothly, but if we can eventually reach the same results, the market result should also be similar.

As for other regions, Europe also has significant firepower. Of the EUR1.35tn package approved, there remained EUR850bn unused as of 10 September. In China, local governments must sell CNY3.75tn worth of so-called special bonds by the end of October, with CNY2.27tn issued by the end of July. That’s already more than in the whole of 2019, and the government is hoping this will jump-start private spending and investment.

Ultimately, the use of a fiscal stimulus is not a solution. It’s a stop-gap measure to attempt to contain the damage to the economy until the impact of the virus is mitigated in some fashion, either through social policy (where the efficacy has been mixed) or through a medical solution.

Conclusion

On a 3-6 month view, we are mildly constructive on the equity market. In the short term, the market is understandably fragile and any adverse news could add to existing headwinds. However, the major governments are not without firepower, and while there are delays to enactment and efficacy of stimulus measures, on balance, global economies should receive enough support to be maintained until a more permanent solution is found. In a sense, the criticism of these stimulus measures is familiar with what China has faced regularly over the last 20 years – that the dependence on liquidity-driven growth and repair of the economy during difficult periods would result in an economic implosion. During that time China’s economy has grown 12 times, from a USD1.2tn economy to a USD14.4tn economy.

Last month we suggested clients maintain a diversified portfolio, within their equity portfolio as well including asset classes that have low correlation to equity. Given the current economic, political and market headwinds, we reiterate this advice.

Short Market Comment

September was a difficult month for equity markets as MSCI ACWI (developed and EM) dropped -3.4%. Tech stocks were particularly hard hit as the NASDAQ fell -12% from peak to trough before recovery a little to be down -5.2% for the month. Further, against the trend was the 2.1% rise in the USD Index and Gold fell -4.2%. Commodities also gave up ground with WTI oil falling -5.6% the London Metals Index fell -1.6%. One of the few places to hide was investment-grade credit which was flat for the month.

If you like to receive more information on our portfolios solutions, please contact us here: info@odysseycapital-group.com

Market Update: September 2020

Sep 23, 2020 | Articles, Global Markets Update

Market Update: August 2020

Aug 7, 2020 | Articles, Global Markets Update

Market View

The Big Dilemma

The current Yield to Worst for the Bloomberg Barclays Global Agg Credit Total Return Index, a Global USD Credit Index, is 1.5%. This may seem a low return, however, fund flow data suggests that investors prefer to get a suboptimal low return than experience the uncertainty of the equity market. Even as the MSCI World net return posted a 19% increase in Q2, Lipper data showed USD86bn left Equity Funds while Taxable Fixed Income Funds saw a USD198bn increase. A significant proportion of the latter when to high yield (HY) funds due to the attractive credit spread and yield in April and May.

Multi-asset absolute return portfolio managers now face a difficult decision. At the end of March, Credit was an attractive haven after the COVID sell-off because Global Credit spreads had widened by 120bp and the Yield was a decent 3%. Global HY was even more juicy with spreads widening by 450bp and the yield was 10.5%. The high carry and the potential for capital gains, especially with the US government back-stopping the US credit markets, was irresistible for fixed income veterans, a virtual slam dunk.

However, now with credit spreads, and in particular, yields, approaching pre-COVID levels, the outlook for returns is greatly diminished. The Global Credit Index has returned 7% YTD, and those that focus mostly on that asset class, may well decide that is sufficient for 2020 and rest on their good fortune. For those of us that are still trying to optimize their returns going forward, the return outlook for credit is unappetizing, and we must judiciously look further afield.

The Choices

Many of us are in the same boat. Whether we are a retiree or still working, an endowment, a sovereign wealth fund, or an insurance company, we all have future liabilities that need to be paid for through investments. This means we need to get an adequate return on those investments. The required rate of return will depend on your particular situation, but for most the number will be between 5-10% over the cycle. Let’s pick a round number and say we want a 7% return. If our investable universe is Bonds (Credit), Equity and Alternatives, and our Bond portfolio provide a 3.2% YTM (70:30 mix of investment grade and HY), then Equity and Alternatives combined must make 9% in the next 12 months.

Source:  Odyssey

For Equity, if earnings are not adjusted higher than current estimates, it would mean that the 2021 MSCI World Index PER would need to be 19.5x (currently 17.8). Apart from extraordinary circumstances such as COVID and the Dotcom boom, the Equity market has only traded as high as 18x – at the peak of the 2017 and 2019 bull rallies. For those that say we now have zero interest rates, so equity multiples can be higher than previously, I would point out that we’ve just had 7 years of zero interest rates in the US from 2009 to 2015. We are not saying you cannot make 9% return from your equity portfolio over the next 12 months, and we hope you do, but we suspect the equity market needs to have a number of positive developments that are not currently apparent for the broad indices to enjoy that type of return.

S&P500 and Current Year PE Ratio

Source: Bloomberg

Can Alternatives bridge the gap? The HFR Hedge Fund Index (HFRHFI) has return 1.6% YTD, which is marginally better than the broad Equity Indices, however, the 6% total return in the last 5 years hardly inspires confidence. The HF Index has even underperformed the Global Credit Index by 24%.

But what about the illiquid strategies? Despite a significant lag in valuation in many cases, unlisted investments do not appear to have gone unscathed. In March AustralianSuper announced they had marked down their unlisted investments by 7.5%. For Q1, Softbank’s Vision Fund with USD76bn invested, lost USD17bn yoy. Carlyle’s Tactical Private Credit Fund’s NAV fell 18% due to COVID and has since recovered approximately half the loss. Commercial real estate has been a mixed bag. Office and industrial exposures have been largely resilient while traditional retail and hotels have suffered and will likely take some time to recover to pre-COVID levels.

Despite some recent losses, there appears a strategic move on the part of large institutional investors to gain further exposure to unlisted investments. Even AustralianSuper is looking to beef its private equity exposure and Calpers has recently stated it believes it needs to raise its exposure to private equity and credit investments if it’s to reach its 7% per annum return target over the next 10 years.

Data tends to support this strategic move by large institutional investors. In H1 2020, private equity experienced USD241bn in fund inflow, USD7bn more than H1 2019[1], despite COVID. While much of the investments were made prior to the COVID lockdown, it indicates the underlying demand. Further, while the number of private secondary transactions declining by 30%, the USD44bn raised in H1 2020 was more than the whole of 2019 (USD26bn)[2], indicating the high demand for secondary transactions.

Source: Prequin

Conclusion

The current low yield environment means that for investors that are continually trying to create a portfolio that can provide 5-10% returns going forward, more risk needs to be taken beyond the relative safety of the credit markets. Whether that is through the highly liquid but volatile public equity market, or via unlisted vehicles, or a combination of both, depends on the goals of the individual investor. From our experience, most private investors are underweight alternative assets and further investment in this asset class would likely increase diversification, boost long term returns and lower overall portfolio volatility.

[1] Private Equity International

[2] Prequin

If you like to receive more information on our portfolios solutions, please contact us here: info@odysseycapital-group.com

Capital Pulse – July 2020

Jul 21, 2020 | Articles, Global Markets Update

HEDGING LISTING POSITIONS

We provided an introductory discussion on secondary listing in the June edition of Lex Capitis. In this month’s Capital Pulse, we delve deeper into this category of listed companies and the renewed interest in this space.

The possible legislation of the Holding Foreign Companies Accountable Act (“HFAA”) and the timely creation of Chapter 19C in the Stock Exchange of Hong Kong (“Exchange”) listing rules (“Listing Rules” ) late last year has revitalised secondary listings in Hong Kong.

The recent listings of Alibaba, Netease and JD.com have raised HK$163.04 billion, and further similar secondary listings are expected. With the exception of these recent secondary listings, such listings have traditionally been far and few.

Typically, companies secondary list in Hong Kong because their business has a major exposure to Asia, but their home stock exchange is not based in Asia. Alternatively, Asian companies obtain a secondary listing in Hong Kong because most of its business are concentrated in Hong Kong and/or China.

However, from an investor point of view, secondary listings do not offer much to investors, unless there is an arbitrage opportunity in the IPO with its already listed shares in an overseas exchange, because investors can purchase those company’s shares in their home stock exchange. The only exception to this case is mainland Chinese investors that rely on the stock-connect arrangements with overseas stock exchanges to purchase international shares.

Since 1999, Hong Kong only had 13 companies that chose to obtain a secondary listing status in Hong Kong because these companies believed their business would benefit tangibly or intangibly from a secondary listing status. However, seven of these companies has delisted predominantly due to low trading volumes of its secondary listed shares. The history of secondary listed companies in Hong Kong since 1999 is presented in Table 1 below.

Given the current geopolitical environment, the HKEX might benefit from the return of large Chinese companies listed in the USA via a secondary listing and, thus, Hong Kong retaining its status as a premier exchange to raise capital in 2020. However, with the unrelenting ravaging impact of Covid-19 on the real economy, one would wonder whether there are any more rabbits left in the hat?  Perhaps recent announcement by the CEO of the HKEX not to renew his contract could be telling.

Table 1: Secondary Listings in Hong Kong

Source: HKEX, Bloomberg

WHY DID THOU REJECT OR RETURN?

The Exchange published its annual listing decision on applications that it rejected and returned in the past year. The primary cause for rejection is as follows:

Table 2: Reasons for rejection of IPO application

Source: HKEX-GL126-2020

The Exchange continues its practice to vet the commercial rationale for listing as the main factor in determining suitability. The question on valuation of the business usually rides on the back of the commercial rationale concerns. Based on the drafting of the rejection listing decision, it appears the failure to meet the profit requirement stems from a lack of understanding of the Listing Rules. These rejection highlights the importance of careful homework, planning and independent advice on the part of these companies that would have saved them a lot of money and heartache.

The Exchange highlighted two returned applications last year and provided more guidance on the inclusion of financial information rule on the application process which may suggest a substantial number of applications were returned as it fell afoul of this rule.  For simplicity, we provided a tabular version of the guidance.

Table 3: Financial Performance disclosure requirements

* Depending on availability

Source: HKEX-GL127-2020, HKEX-GL56-13, HKEX-GL25-11

Although this appears to be a simple guidance to follow, there were media reports of a large biotechnology company that, was listed earlier this year, had its initial application for IPO returned because it did not adhere the guidance above.

Odyssey Corporate Advisory is a boutique corporate advisor providing independent and impartial investment and capital markets consultancy services catered for your circumstances and preferences. Corporate Advisory is a division of Odyssey Asset Management Ltd, a Type 1, 4 and 9 SFC licensed company and subsidiary of the Odyssey Group. If you have any enquiries, please contact:

Kuan Yu Oh
Managing Director, Co-Head of Corporate Advisory
Mobile: +852 6971-7989
Email: kuanyu.oh@odysseycapital-group.com

Notice

This publication is for informational purposes only and does not address the circumstances of any particular individual or entity. It does not constitute financial advice and should not be used as such. You should seek a duly licensed professional for investment advice. For more information about please see our Disclaimer.