Investing in a Brave New World

As the world grapples with high inflation, it is clear that inflation is becoming more persistent than previously anticipated. This is difficult not only for consumers, but also for investors.

Concerns about stagflation risks have hit both bond and equity markets this year, creating a double whammy for investors. As a result of higher inflationary pressures, central banks have begun to tighten policy, and bonds have fallen sharply. Equities were also impacted by policy tightening, concerns about inflation eroding into margins, and the slowing economic cycle.

With both bonds and equities falling, there seem to be few safe havens, but there is some ray of hope.

If inflation gradually begins to level off and economic growth slows, some central banks may hike less than markets currently anticipate. As a result, opportunities for short-term global investment grade bonds will emerge.

On the growth front, the global momentum is clearly slowing, but the earnings season has shown that many high-quality companies are still achieving solid profit growth, though the earnings outlook will become more difficult with an impending earnings downgrade.

The fact that parts of the developed economies and Southeast Asia are experiencing relatively stronger growth should help keep the global economy from entering a recession. We are also anticipating that Mainland China’s stimulus will begin to stimulate activity in the second half of 2022.

Southeast Asia coping better

Despite the global uncertainty, the markets in Southeast Asia, have been particularly resilient. Southeast Asia is reopening its doors to the pandemic, resulting in a surge in consumer spending. Tourism is likely to be strong for the region.

Higher commodity prices benefit commodity-exporting Southeast Asian countries in the short run, and inflation has been less of a problem.

Since late last year, we’ve been positive on the region.

The question is, should we continue our optimism for the region?

The answer is that we need to be more selective in Southeast Asia.

Some things have changed.

The global trade cycle is cooling, and rising food costs will hurt the region, pushing up inflation and forcing central banks to tighten monetary policy in the months ahead.

While the short-term outlook for region is looking to be more challenging, the long-term prospect of Southeast Asia remains bright.

Position for longer term trends in Southeast Asia

The adoption of the Regional Comprehensive Economic Partnership (RCEP) will be a game changer for Southeast Asia, as it will re-ignite a new cycle of investment and infrastructure spending for the region, which has been put on hold for the past two years.

The move toward automation and regionalisation of supply chains will benefit Southeast Asia, especially Malaysia, as it will stand to gain from more foreign direct investments.

Looking ahead, Southeast Asia is a kaleidoscope of strengths. Indonesia’s natural resources, Singapore’s well-established financial centre, Malaysia’s semiconductor chip manufacturing prowess, and Thailand’s strong automotive sector are all factors to consider. Southeast Asia has the potential to become a dominant manufacturing hub of the future, based on automation, robots, and artificial intelligence, as a region through the free trade agreement.

Don’t ignore Southeast Asia’s green transition

Southeast Asia’s green transition has the potential to create more than USD$1 trillion in annual economic opportunities by 2030, according to Bain.

For investors, Southeast Asia’s green transition is an emerging thematic trend.

The region is expecting a population surge of 90 million in the next decade, which will put more stress on existing infrastructure. Cities are a key contributor to climate change responsible for 75% of carbon emissions, with transport and buildings being the largest emitters. Smart building solutions can unlock cost savings by adopting efficient energy usage.

In Malaysia, Smart Selangor is focused on making Selangor a liveable Smart State in ASEAN by 2025. This initiative will spur investments within the digital infrastructure ecosystem.

Moreover, resource extraction and energy generation are still very much coal-reliant and inefficient in the region, and must be decarbonised in a sustainable manner. Malaysia specifically plans to increase the share of renewable energy sources in its installed capacity to 31% by 2025, and 40% by 2035 under its power generation plan. This will require huge changes for the country over the next few years including large scale solar power growth.

Agricultural practices are also inefficient in many parts of the region and are threatening ASEAN’s food security. Employing technology and localising production are key to feeding a growing and large urban population in a sustainable manner. Also take for instance the upside in development of alternative plant-based protein, which is estimated to generate $14 billion by 2025, globally.

The investment case for Southeast Asia’s green opportunities will evolve from a small set of pure play renewable and clean tech companies to a broader set of opportunities across the whole economy that spans from sustainable infrastructure, transport and agriculture.

Investment Strategy

While the adoption of RCEP and Southeast Asia’s green transition are compelling investment themes over the long haul, there is a need for investors to raise portfolio resilience for the short-term, so that they can be opportunistic for long-term opportunities.

To increase portfolio resilience in the nearer term, we prioritise quality, income, and diversification to reduce volatility while remaining invested and capturing the upside we anticipate in the second half of the year.

Quality is crucial in selecting companies and sectors with the most resilient fundamentals; income from multiple sources capitalises on higher yields while dampening volatility; and diversification helps in identifying uncorrelated opportunities in alternative assets.

Periods of unusually high inflation necessitate a shift in investment strategy and asset allocation toward asset classes, sectors, and investment styles that benefit from it or are relatively resilient in an inflationary environment.

As a result, investors require differentiated investment strategies and asset mixes, which they may not employ during periods of low interest rates and inflation. A traditional 60/40 equity-bond portfolio is insufficient. There is a need to diversify one’s portfolio and include alternatives such as commodities, real estate, private markets, and hedge funds.

Commodities and other assets that can potentially act as an inflation hedge such as precious metals, infrastructure or inflation-linked bonds, may be beneficial additions to an inflation-fighting portfolio.

Persistently high inflation may also contribute to a more volatile macro environment, with interest rates and currencies behaving more erratically than in the past, creating more opportunities for dynamic fixed income and hedge fund strategies.

In an uncertain world undergoing unprecedented change, it is prudent to build resilient portfolios to withstand the inevitable bouts of volatility, but it would be imprudent to overlook the wide range of opportunities that will emerge from this landscape.

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