Asia‑Pacific: A Broader Investment Landscape in 2016

In the turbulent market environment, five longer-term investment trends stand out for 2016.

It has been a turbulent year for Asia’s financial markets. In the following interview, Eric Mogelof, head of Asia-Pacific at PIMCO, puts events in perspective and discusses investment trends in the region for the year ahead.

Q: Looking across the landscape of Asia-Pacific in 2016, how have markets and investor preferences evolved over the past year?

Mogelof: It’s important to note at the outset what has not changed. Investors are still anticipating lower forward-looking returns in both the fixed income and equity markets. We are still seeing developed markets outperforming emerging markets (with a few select exceptions). And we are still seeing strong investor preference for income-oriented strategies and solutions with the aim of reducing portfolio volatility.

In terms of key changes, first and foremost, the U.S. Federal Reserve has moved to raise rates while other central banks continue to ease. Second, oil prices have fallen precipitously. Third, global equity markets have been falling since the start of 2016, with much of the volatility and uncertainty stemming from Chinese markets. As our portfolio managers noted in their global and regional cyclical outlooks, we expect central banks to do what they can to calm markets and promote stability, though recent market volatility is suggesting that their ability to do so may be diminishing.

Therefore, while we do not see a global recession at hand, we do think investors will more aggressively seek to damp volatility in their portfolios through a range of strategies, from multi-asset solutions to strategic fixed income to alternatives. We also expect some valuations to become attractive once again for investors.

Q: How does this environment translate into key investment themes for 2016?

Mogelof: In looking at key regional and asset allocation themes, I would point to five trends.

First, in Japan, investors are increasingly responding favorably to the government’s push to migrate savers toward riskier assets.

Second, in China, investors are seeking global solutions as the local markets remain volatile. In addition, Chinese regulators are generally (though not uniformly) working to attract and support inbound capital flows from global investors.

Third, in Australia and New Zealand, given superannuation reforms, investors are focusing more intensely on strategic retirement solutions that can provide both income and capital appreciation after they leave the work force.

Fourth, we continue to see tremendous interest in income-oriented strategies throughout Asia-Pacific, especially in solutions with exposure to the credit markets and bank capital.

Fifth, alternatives continue to gain importance in Asia-Pacific investor portfolios, with particular emphasis on credit-oriented strategies.

Q: Let’s start with the first three themes – the regional developments. First, in Japan, how is the move away from savings vehicles playing out?

Mogelof: It’s widely known that a core goal of Abenomics is to drive investors, both institutional and individual, out of cash savings and into assets with higher return potential. The Abe government hopes this move will help increase consumption and therefore stimulate the economy.

As a result, institutional investors previously confined to holding massive quantities of JGBs (Japanese Government Bonds) are now expanding into global fixed income, equity, multi-asset strategies and even alternatives. A particular area of focus for these institutional investors is buy-and-maintain credit, given attractive relative value. PIMCO has built strategic partnerships with many of these institutions, delivering customized investment solutions that aim to increase the risk-adjusted return of their portfolios. Among pension funds, we see increased interest in alternatives as plans seek higher-returning vehicles to help meet liabilities while limiting volatility.

Turning to individual investors, new programs are geared to encourage investors to put their savings to work, including the Nippon Individual Savings Account (NISA), which allows investments of up to ¥1 million per year to grow free of capital gains taxes for five years, and Junior NISA (a similar structure for minors with a lower limit). PIMCO and our distribution partners in Japan are developing solutions to help individual investors find strategic opportunities to leverage the regulatory tailwinds and migrate from savings to investment. For example, migrating from a cash dominated portfolio to lower-risk, moderate-duration fixed income may meaningfully increase a portfolio’s return profile with limited additional risk. Our Japan portfolio management team has an established track record of managing JGB strategies for local (and global) investors.

Q: Turning to China, how should investors both inside and outside China approach opportunities in view of recent market volatility?

Mogelof: With China, it’s critical to distinguish between outbound and inbound investments. In terms of outbound investments – i.e., global solutions for local Chinese investors – demand has obviously increased in the wake of the equity market turbulence and currency devaluation. While the government is taking certain steps to protect its domestic capital base ‒ limiting quotas for Chinese investors to invest abroad ‒ we see these restrictions as temporary and still view the opening of the Chinese capital account as a matter of “when,” not if.

In contrast, China has largely welcomed inbound flows and simplified one of the main inbound programs ‒ the Qualified Foreign Institutional Investor program, or QFII. The government is especially focused on flows from sovereign wealth funds and large financial institutions, given the aim of promoting the internationalization of the yuan. Notwithstanding these flows, we expect global investors to remain cautious for some time about re-entering the Chinese equity markets. However, global investor interest in the Chinese bond market may grow alongside liberalization, though investors need to be mindful of currency volatility.

Q: How is PIMCO responding to the increase in retirement-oriented investing in Australia and New Zealand?

Mogelof: These retirement markets, especially Australia’s, are among the fastest-growing globally, and both Aussie and Kiwi investors are increasingly mindful that they are, in many cases, over-allocated to equities and real estate. We have seen increased investor interest in solutions that diversify these allocations, including income, capital securities and liquid alternatives. These strategies can provide meaningful capital appreciation while moderating the equity and real estate risk factors. Importantly, they also can be used to generate income, which is a clear priority for retirees. Building on our strength in Australian fixed interest and in these strategies, we expect to bring more solutions to this market over the next year.

Q: In terms of asset allocation themes, can you elaborate on the region’s focus on income?

Mogelof: Given an aging global population, increased market volatility and lower expected returns in the future, strategies that can provide consistent and dependable income are very much in demand. The preference for income solutions is especially strong in Asia.

PIMCO offers a time-tested suite of income solutions, managed by our Group CIO Dan Ivascyn and supported by an experienced team of portfolio managers (named the 2013 Morningstar U.S. Fixed Income Manager of the Year). We expect the potential benefits of income strategies ‒ consistent income with strong risk-adjusted returns ‒ to drive continued investor demand in 2016. We also expect increased interest in other strategies with healthy income components; these include credit and bank capital strategies, which seek, respectively, to capitalize on “secular winners” in the credit markets and harness arbitrage opportunities in bank debt space.

Q: How do you expect investor interest in alternatives to evolve in 2016?

Mogelof: From individual investors who purchase liquid alternatives to insurance companies seeking to manage volatility to large institutions wishing to earn illiquidity premiums, alternatives are increasingly a strategic component of well-diversified portfolios. In 2016, we think investors will be especially focused on alternatives in the private credit space, given the record level of distressed securities in the market, increased corporate demand for private capital and continued forced-selling that may offer attractive valuations to opportunistic investors.

Q: How would you put the market events of the past year in perspective?

Mogelof: For many Asian investors, the beginning of the year marks a time for portfolio reallocations and redeployment. We would caution against allowing recent market dynamics to overly affect long-term strategic allocations. At the same time, we urge investors to prepare to take advantage of favorable valuations when they present themselves. At PIMCO, we aim to provide perspective on the markets as well as asset allocation support ‒ both qualitatively with macroeconomic expertise and quantitatively with proprietary portfolio analytics.

We wish you a healthy and prosperous year.

The Author

Eric J. Mogelof

Head of U.S. Global Wealth Management

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PIMCO defines “liquid alternatives” as strategies that are without the principal lock-ups of traditional private equity funds and hedge funds and include separate accounts whose holdings can be liquidated at a client’s request subject to current market conditions, mutual funds that can be liquidated at NAV on a daily basis and ETFs that can be liquidated on the secondary market under normal market conditions. There is no guarantee that a security will be able to be liquidated in a timely fashion or when it would be most advantageous to do so.

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Morningstar named Dan Ivascyn and Alfred Murata the 2013 Fixed Income Manager of the Year (US). The Morningstar Fixed Income Fund Manager of the Year (2013) award is based on the strength of the manager, performance, strategy, and firm's stewardship.

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