EM Fixed income and China ‘A’ Shares – Yield and Return in a Low-Return World

Donald Amstad, Chief Operating Officer, APAC Distribution & Head of Investment Specialists for Asia Pacific at Aberdeen Standard Investments sees real value in Emerging Market Debt as an asset class. He gave a lively presentation at the Investment Solutions forum to highlight these fixed-income opportunities, and to advise HNWI clients and the assembled advisers where and how they can buy such instruments. And he also pointed the spotlight to the great China ‘A’ share revaluation bonanza that, he believes, has begun in earnest in 2019.

Amstad began by quipping that he should be called Don not Donald in today’s world and remarking that he is now a YouTube sensation since his August 27, 18-minute video analysis of the world’s coming recession and ensuing crises went viral, with 400,000 hits in two weeks.

“My previous record for a YouTube video was 548 hits, in total!” he jested. “Anyway, please watch it and help me hit the million mark.”

Take two…great opportunities

There are two valid opportunities for Asia’s investors, namely emerging market debt and China 'A' shares.

“There is one theme running through the global economy at the moment,” he observed, “namely uncertainty at all levels – corporate, financial, economic, political and geopolitical. Indecision results, or lack of decision-making at the corporate levels. Where to put a factory these days? The answer is nobody knows any more, everyone is postponing decisions. And for your clients as well, those HNWIs are racked with indecision. Because bond yields are so low and equity prices are so high. What on earth should they do?”

He noted that more than 50 central banks around the world have cut rates this year and at least USD15 trillion of bonds now trade with a negative yield to maturity.

The global no income market

“The fixed income market should be renamed the no income market,” he noted. “Unless you short the 10-year Bond in Germany, for example, so you achieve a positive carry because the 10-year German government bond is yielding minus 50 basis points. Go short minus 50 basis points to earn 50 basis points. A crazy world, I think!”

Amstad explained that the only bond market left with any yield is the US Dollar bond market, and within US Dollar bonds, the best value ASI sees is in short-dated bonds because the yield curve is flat.

“But your clients clearly want more than the 1% to 1.5% on offer there, so perhaps one way is to take greater credit risk in the US, although beware as balance sheets have leveraged up in the past decade, to the point of being more heavily borrowed today than they were in 2007, resulting in over USD3 trillion worth of debt sitting at 'BBB'. And if GDP growth drops off, a tsunami of corporate bonds will soon be in the 'BB' space, including names such as Ford or GE potentially.”

However, Amstad highlighted how emerging market companies have, meanwhile, generally spent the last five years deleveraging. Yet the Aberdeen Standard SICAV I Emerging Markets Bond Fixed Maturity 2023 Fund, which spans the globe of EM fixed income, offers a current YTW of 4.74% on the duration of 3.3 years and average rating of BBB-“That sounds rather good, we think,” he stated.

Biggest and the best

Amstad then shifted his attention to an equity-risk play, namely the China 'A' share market. “Simply, we see it as the biggest and the best opportunity on the planet today from both a beta point of view and an alpha point of view.”

The labour force in China now is actually declining, with somewhere between five million workers net per annum leaving the labour force,, and that is even accelerating because of the one-child policy, because of urbanisation, there are fewer graduates coming into the market. “In short,” he explained, “the demographics in China are terrible.”

As the government moved people from the countryside to the cities, rapid urbanisation needed rapid industrialisation, with the financial system funding this. It has all been incredibly successful - GDP per capita has gone from USD100 to USD10,000 in four decades, and life expectancy has gone from 36 years to 76 years. “No small achievement,” he said, “for 1.4 billion people…”

The next phase, he projects, is four decades of transforming the vast pool of savings accumulated in the past four decades into stable cash flow for a rapidly ageing population and their pensions.

“This,” he concluded, “all has incredible implications for all of you here today because the government is now focusing intently on the quality of assets in the financial system.”

They need pensioners to be able to invest directly or indirectly into bonds that pay coupons and mature at par, or into equities that can pay a dividend and grow that dividend.

To develop a credit and equity culture in China, the government knows that the only way to do that is to open up the doors to foreign investors. “Which is precisely what they are doing through the Hong Kong Bond and Stock Connect system,” he added.

Bargains galore…for now

Amstad then extrapolated that the price the country’s leaders are willing to pay is for houses like Aberdeen Standard Investments, and all the peers to openly go into China and buy the crown jewels of the Chinese financial system at near bargain basement prices.

“We all see Chinese shoppers around the world laden with bags stuffed with designer goods,” he remarked. “They certainly know the price and value of quality goods. But when it comes to financial quality, they remain less sophisticated. Nevertheless, they are incredibly smart and learn fast. We believe quality financial assets in China will, one day soon, become expensive just like everything else they buy.”

China 'A' shares, the second-biggest stock market in the world, remains a virtual casino today, he added, judging by 80% of turnover dominated by retail investors. “2019 is the year the China 'A' share market has started to internationalise, to institutionalise, and to become more professional. It is the real birth date of this market in many ways.”