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Putting funds to work

This article first appeared in Markets, Focus Malaysia, on Sep 10 – 16, 2016.
Published in Focus Malaysia on Sep 09, 2016.

Against the backdrop of significant uncertainties in the global economy, the past few years have seen investors struggling in their hunt for yield.

In fact, as the direction of interest rates, especially of the major economies, remains unclear – and with commodity prices remaining volatile – some funds have decided to stay put on the sidelines while awaiting the return of blue skies.

In mid-June, a Bank of America Merrill Lynch report entitled No Bulls on Bear Mountain revealed that funds were amassing their largest cash piles since 2001 as they trimmed their equity holdings to a four-year low.

Its survey of 213 fund managers found that concerns over ramifications from the UK’s vote to leave the European Union (the Brexit effect) and the ability of governments to boost the fragile global economy were the driving force for funds to hoard cash. Super-loose monetary policy was also found to be a cause for concern.

With the path towards Britain’s exit from the EU remaining vague, it is fair to assume that worries still persist. Investors are also wary over how policymakers, notably governments and central banks, can drive a sluggish economy forward.

During the recently concluded G20 Summit in China, leaders of major economies made new commitments towards boosting growth. Still, some analysts remain unconvinced as to how far the governments are willing to stretch their coffers to realise such goals.

A Reuters report quoted a money market strategist as saying “we have a situation where the central banks are the driving force behind growth. They are keeping heads above the water, so to speak. But that is not durable; politics has to step in. Things that will drive the economy are structural reforms, and for that there needs to be consensus [among policymakers].”

Uncertainty drives cautiousness

Fund managers naturally tend to be more cautious during times of uncertainty because they have to prepare for the potential fall in the value of their holdings within the funds that they are managing, according to Fundsupermart Malaysia general manager Wong Weiyi.

“They may also have to deal with higher-than-expected redemptions from clients,” Wong tells FocusM. “As a result, the cautiousness is reflected in the higher than usual holdings in cash.”

While holding higher levels of cash cushions the fall in the performance of the fund relative to the respective benchmark and also helps to deal with redemption needs, not all funds will choose to hold their fire as a result of the uncertainties. Some events which trigger negative sentiment resulting in the fall of stock or asset prices are perceived as opportunities for a cheaper entry point to some investors, suggests Wong.

“Some contrarian investors use such information to make investment decisions,” he points out. “If most investors are pessimistic and hoarding cash, the contrarian investors would benefit once their pessimistic counterparts see a change in market sentiments and start making investments.”

MTC Asset Management Sdn Bhd (MTC) is one fund taking such a position, according to its founder and deputy chief investment officer Aaron Yew. Nothing that some funds have taken large cash positions, Yew believes that the fundamental role of an investment manager is “to find the beta and alpha” rather than try to predict the future of the global economy.

“When the global market is in the doldrums and there is a negative beta, the alpha will minimise the temporary loses if one is a good investment fund,” he tells FocusM. “If the investment fund is great, then the fund would have held cash in 2015, and have close to fully invested its cash holdings in 2016 given the low asset price that we have observed.”

Target long-term gains

Yew’s colleague and MTC’s chief investment officer Devan Linus says that rather than trying to predict the bottom, a fund should instead employ an optimistic mindset with a long-term view. After all, the slew of bad news stemming from commodity price volatility which sent oil prices tumbling and Brexit which wiped out billions from the UK and European stock exchanges is probably not over.

“Rather than riding the ‘herd mentality’ and holding cash, one should deploy capital immediately and accept some short-term volatility in investment returns,” reckons Linus. “Too many investments have failed to get into the market anywhere close to the bottom and as a result of that, miss a sizeable amount of gains form the market’s subsequent recovery.”

Describing themselves as contrarian investors, the team at MTC sees all the negativity and fear permeating the economic environment as an opportunity. The fund believes that it stands a chance to take advantage of any potential market corrections in the shorter term.

“As human beings, we tend to pay attention to issues that affect the world negatively and as a result of that, over-react,” Linus believes. “Many of us tend to react to short-term performance and therefore never necessarily hold companies long enough to extract its true value.”

Yew admits that during tough economic times, some of MTC’s investments may underperform for short periods due to macro environment. However, he suggest that it is how they react after that period that differentiates them from other funds.

“Much of what follows that initial spurt of underperformance is mostly market psychology, trend chasing flows, and that really is the part that we tend to ignore, especially when we believe in the companies we are investing in,” he suggests.

Choosing the right strategy

In fact, great companies such as Facebook and Google are often not as affected by the negativity in the market. In fact, Yew points out that they have managed to generate positive returns for the year. Similarly, MTC aims to invest in such companies where stock prices tend not to be roiled as much by economic cycles.

Fundsupermart’s Wong says that there is both a need for funds to hold substantial cash portions or to do the exact reverse. His view is that ultimately it depends on the type of individual investors and what their needs are.

Investors who are more sophisticated will want to have more control over the cash allocation of their portfolios.

“They are paying the fund manager for their skillset in picking stocks compared to the fund’s benchmark, so they expect their fund managers to fully deploy their monies,” rationalises Wong. “If the fund manager has too much discretion on how much cash he can keep, it may distort the portfolio of such sophisticated investors. In this regard, holding too much cash is undesirable.”

On the other hand, there are investors who do not use a portfolio approach and instead cherry-pick funds they believe will give them the best returns. Wong says these types of investors would be better off with a fund manager who has more discretion over how much cash can be kept.

“If these fund managers believe the market is heading downwards, they would raise more cash, sometimes up to 30% although they are equity fund managers,” he points out. “When these fund managers make good calls, the investors benefit from the more resilient performance.”

Given that there are pros and cons to each style of investing, Wong advises investors to factor in how much cash a fund is mandated to hold, when considering an investment option.

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