Identifying superior investment prospects

Sophia Li: To us, the investment case for Japan has nothing to do with the macro environment. Rather, we seek to back globally-competitive companies and local domestic disruptors that can win market share from complacent incumbents.

We believe Japan is a perfect market for bottom-up active investors like FSSA who have a contrarian perspective to deliver active returns. More than 70% of the listed companies in Japan are covered by only one analyst, or none at all. In addition, if we look at the number of 10-baggers in Japan (defined as stocks that have delivered returns of more than 10 times the amount of its initial investment over the past 10 years) it is only second to China and is far higher than India or other Asian countries.

Jimmy Choong: Our baseline scenario is for price pressures to ease over 2022 as supply chain disruptions alleviate and pandemic related distortions wear off, with inflation likely to remain likely contained over the medium-term.  Equity premiums remains significantly higher than those for fixed income assets while on historical basis, stocks outperforms bonds while labour markets improve.  Asian equities stand out from a valuation perspective while Asian high yield spreads have widened year-to-date and look attractive.  Defaults are not systemic in nature as most situations are idiosyncratic events.

Shen Tan: Lazard is optimistic on the convertible bond market’s performance in the coming months, helped by an ongoing global vaccination campaign and continued accommodative monetary policies. We believe that the accelerating reopening of the European economies will lead to a surge in discretionary spending by consumers, who have been saving heavily, and for a rebound in tourism and recovery-related stocks. Innovation and growth stocks still offer strong and often improving fundamentals in our analysis, as shown by the recent quarterly releases. This situation resembles the one in the beginning of 2016, when a sharp correction was followed by an almost uninterrupted rebound for two years. Thus, we believe the market is favorable for convertible bonds based on a positive outlook on the recovery, and attractive valuations in the technology sector, the largest sector in the convertible bond market.

Li: We seek globally-competitive companies and local domestic disruptors that can win market share from complacent incumbents. You can find a large number of companies in Japan which have strong global franchises and dominant market share in secular growth industries such as factory automation, machine vision, medical equipment and semiconductors.

Secondly, we see strong Japanese consumer brands benefitting from the favourable demographics in Asia, which accounts for more than 60% of the global population. Not to mention the rising number of middle-income families in Asia with increasing consumption power.

Thirdly, we believe there are even more investment opportunities among the purely domestic Japanese companies. We tend to find hidden gems in the underpenetrated and emerging industries in Japan — such as e-commerce, digital payments and Software-as-a- Service (SaaS). They are often under-researched by the market and this is what really makes Japan an interesting investment destination.

Choong: Asian assets remain the stand-out valuation opportunity, providing both income and capital growth opportunity.  Asia Real Estate sector provides stable income, higher dividend yields and good diversification.

Tan: Over the first six months of the year, we saw a rotation against growth companies (particularly mid-cap technology and communication sectors), which represent a large share of the convertible bond universe when compared to global equity indices. However, we are encouraged by the recovery in these stocks over the last few months, supported by strong earnings reports. We believe opportunities continue remain available in these sectors. 

Meanwhile, tourism-related companies have become an important segment in the asset class, following strong issuance volumes since the start of the Covid-19 crisis. The recent announcement of US borders reopening to European travelers starting in November is an encouraging sign for such companies, as well as for airlines with an international focus.

Li: We do not see short-term market volatility as a kind of risk. Instead, we define risk as the permanent loss of client capital — and to protect against that risk, we believe the most important thing we can do is stay disciplined in picking quality companies.

As a team, we have a relatively long-term investment horizon of at least three-to-five years if not more. However, lower-quality companies tend to generate mediocre returns over the cycle and are often cheap for a reason.

In fact, we do not take any macro view — when we invest in a company, we look for businesses that can generate sustainable returns and growth that is unrelated to the macro environment. That said, we have very limited exposure to sectors such as financials, utilities and real estate, which in our view have structural issues and low growth opportunity.

Choong: Sticky inflation, pandemic developments and policy tightening.  More persistent pressures trigger a bond market tantrum, hitting risk asset performance.  Slow vaccine rollout in some parts may see pandemic drags amid the impact of variants.  Vaccine complacency could mean premature policy withdrawal.

Tan: There are several main risks to monitor when investing in convertible bonds:

• As a fixed income instrument, credit risk is the primary risk for convertible bonds.
• Convertible bonds are subject to risks from interest rate and credit spread movements, albeit to a lesser extent relative to straight bonds.
• Convertible bonds are highly correlated with equity markets due to their equity options, and can be impacted by declines in value of their underlying equities.
• Convertible bonds tend to be issued by growth or mid-cap companies, as convertible bonds present a cheaper alternative of financing compared to straight bonds. Hence, investing in these convertible bonds may be riskier than investing in large-cap companies.
• Convertible bonds are typically unsecured debt, and are of lower priority than straight bonds in the event of defaults. Hence, investors may not be repaid the full amount.