Time to view China and Japan through another lens

Yu-Ming Wang, chief investment officer at the $160 billion Nikko Asset Management, tells Jame DiBiasio why the West has China wrong — and Japan too.
Shinzo Abe
Shinzo Abe

Yu-Ming Wang is chief investment officer at the $160 billion Nikko Asset Management. A native of Taiwan, Wang is based in Tokyo and also spent many years as an investment banker in New York. He tells Jame DiBiasio why the West has China wrong — and Japan too.

 

You run global portfolios from Japan. How does the world look from a yen perspective?
I joined Nikko [in January 2013] just as Abenomics was taking off. For Japanese investors, asset allocation has been about diversification. We have introduced funds targeting US equities and debt-oriented European high-dividend strategies. The move among Japanese investors, both retail and institutional, continues to be to diversify away from the yen. There are many signs that Japanese investors are taking on more risk. Too many assets are tied up in cash or non-earning assets. Government initiatives such as Nisa [Nippon Individual Savings Accounts] encourage our clients to look at risk assets. So far this shift has been focused on equities, but we’re at the beginning of a multi-year process.

Do equities still look attractive, even after the run-ups last year?
Yes, it’s a durable theme. Our house call is that global equities will deliver double-digit returns. The market is volatile, but 2014 will still be a good year to be in equities. The world is benefiting from QE [quantitative easing] stimulus, even if the US has begun to withdraw: economic growth is intact in the US, and it’s starting in Europe. But growth is not strong enough for the US to bring forward the timing on eventual rises in interest rates. And Japan remains very accommodative.

How do Japanese investors see the rest of Asia?
Our teams in Tokyo and Singapore agree that North Asian equities will outperform markets in Southeast Asia and India. That is a departure from the previous few years, in which Southeast Asian stock markets did well. In general, North Asia is less dependent on debt and it is also more leveraged to a US recovery. Japan is the best example of this, but it also applies to China, Taiwan and Korea.

Are you worried about China’s debt problems?
China’s been hammered way too much by analysts in the West. These people are looking at China through the wrong lens. China does have a debt problem but one that it can handle smoothly. In fact it is useful to the reformers in Beijing to talk up these problems, because it makes it easier for them to push for reforms. We like the stock-picking opportunity in China, whether they are listed in Hong Kong or if we access them through our QFII account [as a qualified foreign institutional investor].

How will defaults play out in China?
There are laws in China for this sort of thing but they are new and untested. There is a history of defaults, though, and they have always been in the form of negotiated settlements. There is no procedure for a US-style bankruptcy court procedure. Any impact of a settlement on the overall economy is within Beijing’s ability to control. I’m sanguine about China as an investment destination; its debt problems will dampen its growth rate, but a Lehman Brothers-style bank run won’t happen in China.

Are Japanese investment flows headed to China, or elsewhere in Asia?
While Japanese investors are diversifying abroad, they retain a conservative profile. Our international funds concentrate on sovereign debt or currencies of countries with high credit ratings. Flows go to the safer half of the fixed-income world. Within equities, income remains the dominant theme. That’s why our US and global Reit funds continue to do well, as well as funds with other income themes. Safety is the top concern for Japanese investors. We’d argue that Asia ex-Japan is different from emerging markets elsewhere. Even India and Indonesia now show signs of stability while other markets do not, but the emerging market story isn’t winning the day among Japanese investors.

Are people in Japan more upbeat about Abenomics?
Anecdotally I’d say yes. I’ve only lived in Tokyo since late 2012 so I’m not really the expert. But when I arrived, buildings catering to foreign expats were half full; today they are completely rented out. Executives hired from abroad now have to fight for expat housing. Tourist hotels’ occupancy rates have grown full thanks to the weak yen.

The weak yen may be good for the tourist trade, but is it enough for the economy?
The gist of Abenomics has succeeded. He is the first leader to break the strong yen, something that his predecessors all attempted but failed to do. Secondly, he has changed expectations around inflation, from negative to slightly positive, for the first time in two decades. This is beginning to be reflected in prices. Lastly he is reviving animal spirits, albeit slowly. But initiatives such as Nisa are encouraging people to buy equities again, and companies are being urged to provide better return on equity to shareholders.

What does that mean for you as an investor?
We have done well over the past 12 months by investing in financial services and building infrastructure, which were and remain cheap. Land prices are starting to turn around. We like export-oriented industrials and domestic-demand stories. In fact most of Japan’s recovery has been domestic: the US and Europe have been too weak to support much in the way of exports.

What about Japan’s other structural problems?
The list of worries about Japan is still there. Demographics is the biggest one, along with low interest rates, overborrowing and wages that won’t rise. But demography is overplayed as a story: it’s a real issue but one that is fully reflected in stock valuations. We’ve had 20 years of declining nominal GDP so these trends are no secret. Moreover, Japan has been at the front of the demographic wave — the same wave that is starting to hit other major economies and will impact them over the next 20 years. China. Taiwan. Europe. What does stand out in Japan’s favour is its per capita GDP, which is very attractive.

Is Abenomics affecting appetite for JGBs?
That’s my worry and I’m bearish on JGBs from an interest rate perspective. But I don’t see rates jumping in a dramatic way. Foreign participation in our treasury market is only 8% of the outstanding. It remains dominated by the Bank of Japan, the GPIF [a government pension fund] and other major domestic institutions. Any rise in interest rates will be orderly. It’s true that Japan’s level of debt is beyond any metric used for other countries, but it’s owed to the local population, not to foreigners.

Aren’t foreigners buying more JGBs these days?
Not at a level that it becomes a systemic issue. Another point is this debt is held by the private sector, unlike in China’s case, for example. If Japan stimulates economic growth, it can grow out of this debt. This spring, a new sales tax comes into force, and that will also help to restore fiscal balance.

What assets do you dislike?
It’s been a mistake to approach emerging markets homogeneously. You have to ask whether a given country can afford its debts, if it has the cash flow? Twin deficit countries [budget and trade deficits] continually need to borrow, and they will face adjustments. High yield debt has been red hot because so many investors have been willing to buy it at any price. I wouldn’t continue to buy it today. In the fixed-income world, anything below investment grade is definitely expensively priced.

How do you analyse spread opportunities in fixed income?
I’m driven by liquidity. That can be hard to price, but you know it when you don’t have it. It’s true for many emerging markets that once others begin to exit, liquidity becomes a challenge. That’s even more true now with bank capital rules coming into force, which have forced broker-dealers to cut their capacity to trade these instruments.

Are the emerging markets financially sound?
Many have been living in fantasy land, enjoying developed countries’ zero interest rates and stimulus. Developed countries have run monetary policy as a giant experiment for the past several years, and we don’t have a precedent. Now as that policy begins to normalise, we’re going to find out which companies’ earnings are due to a sound business model, or to debt.

You mentioned that India and Indonesia are better off than many of their peers. Are you overweight or underweight these two?
Our view on equities is to be overweight North Asia. But in fixed income, we have recently moved from underweight to neutral in these two markets. And we might move to overweight. Both countries have taken dramatic measures to restore fiscal discipline. The major unknown in both cases is elections this year. But in both cases we are more sanguine about the outcome.

The article has been amended to reflect the fact Wang joined Nikko in January 2013.

¬ Haymarket Media Limited. All rights reserved.