Cover Story: From roller coaster ride to tightrope walk

This article first appeared in Wealth, The Edge Malaysia Weekly, on March 28, 2022 - April 03, 2022.
Cover Story: From roller coaster ride to tightrope walk
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If fund managers found themselves riding a roller coaster two years ago after the pandemic struck, 2021 was akin to walking a tightrope. The market was calmer than in the previous year, giving it more time to think and react, but it had to stay vigilant at all times.

“We would describe last year’s investing journey as walking a tightrope. It was a tricky year to navigate, in large part due to the persistence and escalation of the pandemic rather than the gradual diminishing path some had expected.

“There was progress to be made step by step. But the journey was fraught with event-driven risks such as lockdowns, fiscal controls and threats posed by ESG (environmental, social and governance) considerations,” says Lee Sook Yee, chief investment officer of Kenanga Investors Bhd.

In some aspects, 2021 was more challenging than two years ago as the local market was on a gradual downward trend with less trading activity. Even more frustrating for some fund managers was how the market’s “irrationality” persisted longer than expected, spelling bad news for value investors. They could not bargain hunt as prices of overvalued stocks remained high. It was also hard to take profit as prices of undervalued stocks stayed stubbornly low.

For instance, a significant correction in the share price of glove stocks was expected in late 2020 or early 2021, when a major downward trend was observed in the average selling price of rubber gloves. But that did not materialise as quickly as some fund managers had expected, says Wong Yew Joe, CIO of AmFunds Management Bhd.

“The market did not react commensurately with the market catalyst and positive developments. Sound investment decisions based on fundamentals were not properly rewarded. This really tested the resolve of our team.” > Chue
“We would describe last year’s investing journey as walking a tightrope. It was a tricky year to navigate, in large part due to the persistence and escalation of the pandemic rather than the gradual diminishing path some had expected.” > Lee

“That was because analysts did not sufficiently revise their earnings forecast on glove companies while investors were hopeful that their share price would rebound. We learnt that the market is always right, even if valuations seem to disagree sometimes.”

Chue Kwok Yan, chief investment officer of KAF Investment Funds Bhd, concurs. “The market did not react commensurately with the market catalyst and positive developments. Sound investment decisions based on fundamentals were not properly rewarded. This really tested the resolve of our team.”

Challenges abounded not only in the local equity market last year, but also the bond market. In fact, equity investors may have overlooked the fact that the domestic bond market recorded a negative return last year, for the first time in over a decade, says Roszali Ramlee, CEO of AmanahRaya Investment Management Sdn Bhd (ARIM). Last year was also one of the most challenging years for bond funds since the Asian financial crisis, he adds.

“At the same time, the equity market was in negative territory, which meant that diversification via strategic asset allocation did not work well to mitigate the depreciation in our overall investment values.”

Investors were increasingly diverting their money overseas in 2021 because of the lacklustre performance of the local equity market. But many who put their bets on the China market were not spared from market volatility and unexpected events. For instance, the regulatory crackdown by the Chinese government that impacted its technology sector caught many investors wrong-footed.

David Loh, deputy head of equity at Affin Hwang Asset Management Bhd, found it extremely hard to read the Chinese market and had to diversify some of its funds to other markets with more robust fundamentals. Challenges in the China market were also highlighted by Dr Tan Chong Koay, founder and chief strategist of Pheim Asset Management Bhd, and Yeoh Kim Hong, CEO of Public Mutual Bhd.

As such, outperformance in last year’s market largely depended on fund managers’ discipline in profit-taking and stock-picking ability. For instance, a key reason for Public Mutual’s outperformance was its profit-taking exercise on glove companies when their prices peaked. Its fund manager then invested more heavily in selected semiconductor companies that were expected to benefit from the long-term digitalisation trend. Several other award-winning fund houses, including Kenanga, echoed this view.

“During times of extreme volatility, it is imperative to filter out market noise and focus on assessing the long-term fundamental prospects, balance sheet strengths and valuations of the investee companies,” says Yeoh.

Being flexible and agile were two other essential traits that contributed to outperformance. For instance, Pheim adjusted quickly to the new reality of the China market as early as the end of 2020 when the Chinese government’s regulatory crackdown had just started. The exposure of the Pheim Asia ex-Japan Pacific Fund to the Hong Kong/China market was cut by about half in the following nine months, a bold move that raised the eyebrows of some of its clients.

“Many investors questioned our decisions to cut exposure in the market as they were still bullish on China. However, it was thanks to our sound investment decision that the fund managed to avoid the worst decline in the market last year,” says Tan.

ESG takes centre stage

Taking centre stage in the fund management industry in 2021 was the fast-growing importance of ESG criteria when valuing a company. Companies with good fundamentals and attractive valuations might not see their share price increase over time if they have high exposure to ESG-related risks. Worse still, their share price could be battered when ESG issues are uncovered.

“There are concerns over the government’s ability to increase its revenue or broaden its tax base sufficiently. The Cukai Makmur may be repeated, albeit with a different name.” > Choo

Eastspring Investments Bhd, known by some investors for the attractive returns on its Eastspring Small Cap Fund, was one of the fund houses that faced challenges on the ESG front last year. Some of its investee companies in the manufacturing sector were hit hard by unresolved labour issues, which prompted the firm to put more emphasis on ESG factors in its research process. Head of investment Doreen Choo says the firm encourages its team to have more engagement with companies on ESG-related issues.

Electronic manufacturing service provider ATA IMS Bhd was embroiled in ESG-related issues recently. Its main client, Dyson, was reported to have terminated its contracts with the company last November owing to alleged labour problems, causing ATA IMS’s share price to go into free fall. As at March 14, the company’s share price had collapsed about 85% to a low of 38 sen from RM2.51 last November.

KAF’s Chue shares the view on the importance of ESG, saying value investors must look not only at financial numbers and ratios but also include ESG criteria in their investment decision-making process.

“The fundamental assessment of an investor could be correct, but share price movement is another function affected by, among other factors, liquidity and new evaluation requirements such as ESG criteria. Markets can overshoot or undershoot because of them,” he adds.

ESG-related issues, especially on corporate governance, have much wider implications on investors than some might think. For instance, investors who have done thorough research could still be caught off guard and suffer massive losses if a company’s corporate governance is weak. A company whose corporate governance came under scrutiny was Serba Dinamik Holdings Bhd.

PMB Investment Bhd, which won the Best Equity Malaysia Income (Islamic) award, was unfortunately caught in the Serba Dinamik storm. Its CEO Mahani Ibrahim says some of PMB’s funds had exposure to Serba Dinamik and its related companies, such as Kumpulan Powernet Bhd and Sarawak Consolidated Industries Bhd, last year.

“Their stock prices tanked after the auditor highlighted several audit discrepancies in Serba Dinamik’s accounts. Having the same substantial shareholder resulted in Kumpulan Powernet and Sarawak Consolidated Industries experiencing selling pressure. Fortunately, we managed to dispose of all our holdings in those three companies rather early, but the losses incurred [for us] were quite substantial.

“We can’t say that it was a mistake that we made. Rather, it was an unfortunate event that occurred to us. We opine that auditors should play their role effectively to flag any wrongdoings by companies to ensure their financial data is accurate and reliable,” she says.

Pheim’s Tan had an almost similar experience with a Singapore Exchange (SGX)-listed Chinese company in 2007. Tan and his investment team visited its CEO and concluded that its products had good market potential and enormous demand. The company’s gearing level was acceptable and its share price was undervalued. Pheim then invested in the company in late 2007 and 2008 after conducting further due diligence.

For a while, there was no sign that the company was not doing well. However, in early 2009, the company’s board of directors announced it had difficulty finalising the audit of the group’s trade receivables and cash balance for the financial year ended December 2008.

“An external investigator was appointed in February 2009 to carry out an independent assessment and found numerous financial accounting irregularities and an unauthorised change in the group’s corporate structure. The company had violated SGX’s listing rules by failing to disclose Chinese bank loans on its balance sheets. Trading in the shares was suspended that same month. Even though our exposure to the company was very small, it was a salutary lesson for us,” says Tan.

The lesson he learnt from this was that fund managers have to pay more attention to the details in a company’s accounts and check with its competitors regarding the character of its top management and standard of corporate governance.

Inflation and GE15 in focus

Fund managers are not expecting the ride ahead to be smoother. At the time of writing, the less deadly strain of the Covid-19 virus continued to spread while the conflict between Russia and Ukraine had entered its fourth week with no end in sight. Inflation is rising around the globe, exacerbated by the war as commodity prices, especially for grains and sources of energy, rise to record levels.

A current topic of debate is whether inflation will be transitory or last longer than the market previously thought. Persistent high inflation would leave central banks with no choice but to raise interest rates, which could hurt economic growth globally and the profitability of companies if not carefully done.

Kenanga’s Lee believes that the rising inflation is transitory, which means high year-on-year increases will not occur in the medium to long term.

“It is undeniable that the recent pace and intensity of inflation has surprised central banks and markets. It is reasonable and even necessary that the US Federal Reserve and other central banks utilise rate hikes as a tool to help tackle soaring absolute price levels, besides waiting for supply-side constraints to ease.

“That said, we do view high inflation as still, in essence, transitory. Continued [technological] innovation, expansion of productive capacity and capital mobility to more efficient geographies are all factors that remain as structural checks to long-term price levels. Short-term volatility aside, there remain plenty of opportunities for growth over the long-term horizon,” she says.

Hoo See Kheng, CEO of Hong Leong Asset Management Bhd (HLAM), is confident that central banks have the monetary tools that can be deployed to bring inflation down to a more benign level. At the same time, global growth is expected to slow as monetary and fiscal policies by central banks and governments are tightened.

“Political sentiment will always be the central theme for our local market. Without its political aspect, the Malaysian stock market is like curry chicken without curry. ” > Nazri

Christopher Liew, CEO and chief investment officer of Principal Asset Management Singapore, is of the opinion that inflation will likely moderate or reverse in the latter part of the year, as pressure on the global supply chain eases. “The pressure on the mismatch between market supply and demand [is expected] to reduce as demand shifts back from manufactured goods towards services as more economic activities resume their operations,” he says, adding that the Federal Reserve could hike the interest rate six times this year.

Datuk Dr Nazri Khan, CEO of Inter-Pacific Asset Management Sdn Bhd (InterPac), believes that high inflation will remain transitory. “Inflation has indeed risen to levels not seen since 1982. Yet, the market is far from overheating. The global economy has barely reached its full potential in terms of its level of output and employment.

“We believe the supply chain constraint will clear in time, along with inflation. Global growth should remain resilient, with heightened volatility observed during the initial periods of the rate hike.”

Others, however, are less confident about the inflation outlook for this year. ARIM’s Roszali, for one, expects inflation to be more persistent than transitory moving forward, and global growth to be weaker than some expect on the back of high commodity prices.

Lim Suet Leng, CEO of UOB Asset Management (M) Bhd, shares Roszali’s view, saying that inflation could trend higher than many expect in the medium term. “After a decade or more of low inflation, it looks like it could be higher than expected in the medium term. We see evidence of temporary issues and also potential structural issues.”

According to Lim, the temporary increase in inflation owing to supply constraints is expected to disappear when the pandemic is over. Yet, rising rents and wages are still not reflected in the recent inflation numbers, and could be structurally higher and become a long-term driver of inflation. “However, we do not see this as a repeat of the very high inflation seen in the 1970s,” she adds.

“After a decade or more of low inflation, it looks like it could be higher than expected in the medium term. We see evidence of temporary issues and also potential structural issues.” > Lim

The market will also be looking at whether the one-off prosperity tax introduced in Budget 2022 will be repeated. Eastspring’s Choo notes: “There are concerns over the government’s ability to increase its revenue or broaden its tax base sufficiently. The Cukai Makmur may be repeated, albeit with a different name.”

New government with strong majority is market positive

The 15th General Election (GE15), which is likely to be held in the second half of the year, is another critical event that will be overshadowed by global developments. “It is almost a consensus view [in the industry] that GE15 is likely to take place in 2H2022 as the incumbent parties in the government try to strengthen their political position,” says Kenanga’s Lee.

“We think GE15 is likely to be less of a headwind compared with GE14, and a peaceful conclusion of the election should remove the overhang for our market. We will be more positive on the market if a new government with a strong majority is formed after the election.

“Most fiscal reform measures are now stalled and efforts to strengthen the federal government’s finances are expected to happen only after the election. Mega projects are expected to receive approval only after the election, which should be positive for the construction sector and the country’s economy,” Lee states.

PMB’s Mahani points out that the federal government and the Pakatan Harapan coalition had signed a memorandum of understanding (MoU) on transformation and political stability. One of the conditions in the MoU is that parliament will not be dissolved before July 31, 2022.

“After the MoU lapses, there is a possibility of an early general election [in 2H2022]. We believe the market will closely monitor local political developments. Uncertainty on the political front, especially in the second half of the year, will affect our market performance,” she explains.

Foreign funds are also expected to stay on the sidelines until the dust settles on GE15, adds Goh Wee Peng, CEO of AmFunds.

Regardless, local fund managers are no strangers to local politics, including general elections, even though it will certainly rock the market to various degrees.

“Political sentiment will always be the central theme for our local market. The Malaysian stock market is like curry chicken without curry, without its political aspect. We expect more news headlines coming out by the end of 2022 as well, when the Umno election is expected to take place. More volatility will follow,” says InterPac’s Nazri.