Investors to build on trends already in place

The COVID-19 roller-coaster ride markets experienced in the first half of 2020 should accelerate asset allocation trends already in place among Asia-Pacific-based institutional investors as the year began, market veterans say.

For example, the pandemic — even as it expands the range of potential outcomes — has intensified investors' focus on issues such as ESG investing, including climate change, and the benefits of lessening home country bias, said Simon Coxeter, Singapore-based director of strategic research, growth markets with Mercer Investments.

After a first half mostly spent "managing the here and now," asset owners will likely turn their attention to longer-term, strategic changes in the second half of the year, such as finding alternatives for some of their equity exposures capable of lowering volatility without sacrificing returns, predicted Paul Colwell, Hong Kong-based senior director of investments and head of advisory portfolio group, Asia, with Willis Towers Watson PLC.

Efforts to complement or supplement the role of sovereign bonds as the anchor of risk-off portfolio positions could likewise accelerate, particularly with the U.S. Federal Reserve and other central banks pledging to keep yields near zero for the coming two or three years, observers say.

Discussion continues to pick up regarding "how effective, how efficient" bonds can be as a diversifier in portfolios, said Kirk West, Sydney-based executive director - international business and clients at Principal Global Investors LLC.

Investment-grade credit and alternatives will garner flows as institutional investors explore whether a 60% stock/40% bond portfolio still makes sense in the current market environment, Mr. West predicted.

For LGIASuper, a Brisbane-based superannuation fund managing more than A$12 billion ($8.3 billion) in retirement assets for 75,000 members, the answer appears to be "no."

With the Fed and other developed market policymakers backstopping global markets, "our risk appetite is somewhat unchanged" from the start of the year but the relative attractiveness of some assets has changed "quite dramatically," said Troy Rieck, chief investment officer, in an interview.

Specifically, with sovereign bonds and cash sporting yields now below the rate of inflation, "it's very hard to see them as a core part of your portfolio," he said.

LGIASuper has been shifting assets on the margin from sovereign bonds to investment-grade credit of Australian companies the team feels it understands well, including Suncorp Group Ltd., Qantas Airways Ltd. and Woolworths Group Ltd., Mr. Rieck said.

On a broader scale, LGIASuper's investment team is looking now to "reshape" the risk-off, hedging portion of its portfolio, revisiting some of the more traditional tail-risk hedging strategies such as trend-following and global macro hedge funds, he said.

If putting in place risk-off protection remains on investors' to-do list, most believe the strong monetary and fiscal policy response since late March will give greed the upper hand over fear for the coming year or two.

With expectations that "tremendous support on the monetary side and the fiscal side" can be sustained for the foreseeable future, "people are remaining fully invested," PGI's Mr. West noted.

Even so, it's not a case of being off to the races again.

"On face value, there's been a strong equity market rebound since March but underneath that there's huge differentiation across the spectrum from bankruptcies to companies (like technology heavyweights) that may actually grow faster due to the pandemic," Mercer's Mr. Coxeter said.

If the six top technology stocks in the S&P 500 index are excluded, the "S&P 494 basically trades in line with global ex-U.S. stocks," which remain well below their pre-COVID levels, LGIASuper's Mr. Rieck noted.

Matt Wacher, Sydney-based CIO of Morningstar Investment Management, Asia-Pacific, said the A$200 million multiasset real-return strategy he manages, as part of a A$8 billion book of institutional business, has been taking risk off the table over the past month after putting to work a 30% cash position established — fortuitously — in January.

Some of the stocks the Morningstar team bought with the market's collapse in March — when they took contrarian positions in companies, such as cruise lines, that everyone was selling — had already rebounded close to 100%, he explained.

However, even if the historic monetary and fiscal policy response to the pandemic "shut off completely the negative outcomes that could have occurred back in March," that doesn't mean everything is "hunky dory," Mr. Wacher said.

Instead, over the next quarter, "the solvency of some companies, and potentially a lot of companies," will be called into question, and even those that do survive, if they've taken on debt, will struggle to service that debt — a drag on future growth, Mr. Wacher predicted.

The Fed can boost liquidity but it has far less room to impact solvency and fundamental credit risk, LGIASuper's Mr. Rieck agreed.

Meanwhile, PGI's Mr. West said risk-on sentiment isn't likely to improve sufficiently to spark a resumption of allocations to emerging market stocks and bonds this year from U.S. stocks and bonds. If underlying economic conditions continue to improve this year, that could happen in 2021, he said.

Yet another trend seen last year that's likely to accelerate over the remainder of 2020 is deglobalization driven by geopolitics, Mercer's Mr. Coxeter said.

A shift to resilience from efficiency as the overriding objective in building supply chains will likely depress productivity, which in turn could add to inflationary pressures, he said.

"Given the structural forces accelerated by the pandemic like deglobalization, supply chain restructuring, and differences between countries' ability to combat the pandemic's economic and market impact with fiscal and monetary policy, we could see large divergences in performance across markets and sectors," a backdrop that will favor active management, he said.