George Efstathopoulos, Fidelity
“The big fall in multiples [price-earnings ratios] during the second part of last year made China equities attractive,” Fidelity’s George Efstathopoulos told FSA.
He is co-portfolio manager of two Fidelity products, the Asia Pacific Multi Asset Growth & Income Fund and the Greater China Multi Asset Growth & Income Fund.
The Asia-Pacific fund has a 35% allocation to equities, with half of its holdings in China stocks.
The Greater China fund has a 55% weighting to equities, almost all to mainland China, purchased this year after selling Taiwan equities. The largest sector allocations are to technology, banks and healthcare.
Although the fund managers make asset allocation and portfolio construction decisions and monitor the risk, they leave the bottom-up stock and bond analysis to Fidelity’s specialists.
The two funds are Asia-focused, so they share a “similar direction of travel”, he said.
Last year, that meant deciding that the risk-return profile was better for credit than equities.
In mid-2018, the team made an allocation decision in the Asia-Pacific fund that might have seemed counter-intuitive to other investors: they rotated out of equities into high yield bonds, increasing its exposure to 30% from 10%.
“We started to raise our allocation to dollar-denominated China and Asia high yield bonds in July, which was a very contrarian move,” said Efstathopoulos.
“Equity prices need a catalyst to rise (such as expectations of higher earnings) even when valuations are historically cheap, whereas bonds – especially those with short maturities – are ‘pulled to par’ — either they default or they will pay back their principal at redemption,” he explained.
Last year, spreads over US treasury yields had widened to around 700 basis points.
“Neither macroeconomics nor the fundamental weakness at the credit level was responsible,” he said. “The widening was caused by a lack of liquidity. A credit crunch in the Chinese onshore market prompted by the authorities’ deleveraging campaign that reverberated into the offshore market as investors feared over-supply of new issuance.”
Efstathopolous and his colleagues were comfortable with key metrics, such as interest coverage, for many companies whose dollar-denominated bonds had suffered.
Meanwhile, China’s policy-makers recognised the problems of a credit crunch amid a domestic economic slowdown and against a backdrop of falling markets in the final quarter of the year, and so implemented several monetary and fiscal measures to mitigate the liquidity squeeze.
“As a result, the performance of our China high yield bond positions was flat, providing drawdown protection for the funds as a whole during a period of turbulence in most markets,” he said.
Subsequently, during the rally in the first quarter of 2019, the holdings “saw capital growth and now, as refinancing has taken place with coupons about 100bps more than seasoned issues launched three-to-four years ago, we have locked in higher income streams,” he said.
The funds have retained their exposure to China high yield, while building positions in Chinese equities.
The greatest risks to asset prices last year were the Fed’s hawkish interest rate policy, rising oil prices and a slowdown in the Chines economy,” said George Efstathopoulos.
“These dangers have now largely reversed, although there is always the concern that inflationary pressures might suddenly emerge.”
Fidelity Asia Pacific Multi Asset Growth & Income Fund and Fidelity Greater China Multi Asset Growth & Income Fund vs sector averages