Podcast: equities with Devan Kaloo, Flavia Cheong and Richard Dunbar
Richard Dunbar speaks to Devan Kaloo, Global Head of Equities and Flavia Cheong, Head of Asian Equities in one of the most difficult economic, market and business environments, where fiscal and monetary policy have proved a powerful antidote to early damage done to equity markets when the virus first hit.
ASI EQUITIES PODCAST (08/06/2020) TRANSCRIPT
Voice Over: Investment Insights by Aberdeen Standard Investments.
Richard Dunbar: Hi, my name is Richard Dunbar and welcome to our latest ASI podcast. Today, I am delighted to be joined by Devan Kaloo, Global Head of Equities; and Flavia Cheong, our Head of Asian Equities, joining us from Singapore. Welcome both.
Devan Kaloo: Thank you.
Flavia Cheong: Thank you.
Richard: Now, this discussion takes place virtually, of course, in the midst of one of the most difficult economic market and business environments that any of us will have seen or had to operate in. All of this said an environment where both fiscal and monetary policy have proved a very powerful antidote to the early damage done to equity markets when the impact of the virus first hit. So an opportune time to talk and to take stock of where we are in equities at this point in time.
Perhaps first to Devan; there has been a lot of talk about styles and the facets of stocks that are doing well or badly in this rally and previously downturn. Value and growth most often mentioned, with US tech being the poster child for the latter. Is this replicated more broadly? Is this replicated by region and by market under these appropriate monikers for what we're seeing at the moment in markets?
Devan: Thank you, Richard. I suppose, as ever in these things, it's a bit more complicated than that. When you look at equity markets in general, I would say that they're generally performing in line as expected. You have, with developed markets, quality as a style doing very well. In contrast, issues such as higher beta or more volatile stocks are doing less well. Whereas in emerging markets, while you have quality doing okay, actually what you have is higher beta and more volatile stocks are doing better still, and the biggest driver in terms of markets being price momentum.
Now, if you boiled that down a little, one of the things that we're seeing in emerging markets is that China, and indeed the e-commerce names in China, have been some of the best performing stocks over this very difficult period and for good reason; in that their business models have been relatively robust in the big pandemic sell-off. But when you look at developed markets, you've seen a very clear flight to quality. The one exception perhaps to that is in the US; where rather like in emerging markets, you've see again the e-commerce type names- so the FANGs- doing very, very well. In fact, in the US market, the value in the market has been fairly concentrated in a handful of names. Most stocks are still well off the 2020 start.
It's been a mixed bag in terms of how to perceive and understand the performance. But broadly, quality has done better within that growth. Now, one of the big questions more generally is going forward will that continue? Certainly, there are reasons to suspect that actually some of the other styles, such as value, maybe doing better going forward.
Richard: Presumably that view on value, as you touch on, has implications for broader asset allocation, emerging markets versus developed markets allocations within developed markets?
Devan: Yes, that's right. If we get into a situation where people are less concerned about the pandemic and the anticipation of a faster global recovery comes through, then potentially value would do better. And within that I would say that probably the markets outside the US would do better than the US.
Richard: Within that value argument, I suppose a lot of the areas that are often described as value; airlines, retail, leisure; some of these areas are areas that have been challenged in the decade, I suppose, prior to the virus and have been particularly challenged because of it. Presumably, stock selection and careful analysis is required in terms of delving into some of these broader areas that are defined as value.
Devan: Yes, I would say that. Certainly, you're seeing more generally business models being challenged, and business models that were already facing some headwinds have certainly got much tougher time of it now against the backdrop of a pandemic. That said, I do think it's possible to identify companies which are exceptions to that. One of the key ways to do that, just to focus on whether or not the businesses themselves are being well run, the balance sheet, the cash flow and the like is strong, and potentially allows them the flexibility to be able to capitalize on other stocks or other company's weaknesses.
Richard: Now, Flavia, perhaps further to some of Devan's comment. It may be too early to say who are the winners and losers here, but there is a lot of speculation as to how the virus will change the way we live, work, consume. What are you hearing from companies and how are we thinking about portfolios, both in terms of taking advantage of this but also to protect ourselves from companies that may not prosper in a post-virus landscape?
Flavia: I think that some of these trends that we have looked at post-COVID are not new trends. These are global trends, but the pace of disruption has accelerated as a result of COVID. If I were to take China, for example. We've long been monitoring the stocks, like Meituan which is online food delivery; and GDS, which is a neutral carrier data center provider. It's just trying to understand the way in which they can entrench themselves in the consumption pattern of the Mainland Chinese.
With the correction in markets in March, we were then thinking-- Certainly, while the pattern of change and adaptation has differed from country to country; with China, I think it's most stark that the pattern in which consumers move to online consumption has been quickly accelerated. And the move towards Agile working have brought up questions with respect to data warehouse usage, data usage. How do we think about office property as more people move towards working from home? Then when we think about play, how do we think about aviation?
For example, 9/11 definitely changed the way the aviation industry is operated and COVID will have the same impact. Will this mean that the economics of aviation will change? Do we want to be exposed to this sector? These are some of the discussions that have been going on the desk since March.
Richard: As regards to Asia, in terms of the move to online, et cetera, one of the observations have been that in some Asian economies, Asia was missing out the bricks-and-mortar and moving straight to online. Do you see Asia as being ahead of the rest of the world in some of these trends or do you see these trends as global anywhere and Asia just playing its part?
Flavia: These trends are global but the pace in which consumers have adapted to it differs. So, I think China would be way ahead even of the US when you look at a lot of stats in terms of GMV or consumption. Then you have India and Indonesia, which are pretty far behind but they are really skipping the old economy and going straight into the new economy. If you take telecom, for instance, fixed line is-- They never went through the big movement, fixed line, and moved directly into mobile. You do see that in Asia and the question then is; how do you get exposure to that? Because it's not evident in all markets. In Indonesia and India, for instance, it's pretty difficult to get exposure to that theme.
Also think about how companies work digitization; the speed at which they have had to adapt to that as a result of COVID. We've spoken to a cement company in India which we hold. They are thinking that COVID will have structural changes in terms of the way they work and the way they approach their customers, as well as logistics. We spoke to Ping An, which is one of our investee companies. They talked about how COVID has actually accelerated digitalization and how its agents have had to buy-in very quickly to getting online, which could have probably taken them maybe two or three years, but COVID has really accelerated the entire process, the entire buy-in process.
Richard: Do you think someone like Ping An, for example, do you think that will advantage, if you like, or that necessity to move more online much more quickly than they would otherwise have done? Do you think that gives them competitive advantage relative to some of their global peers?
Flavia: Within China? Definitely, because they have a very strong ecosystem. They have been investing very heavily on Big Data and AI. This means that they can really leverage off the investments that they have spent and get that buy-in and have that result for their insurance agents, and then be able to build on productivity.
Richard: Devan, maybe coming back to you that we've had much debate internally about the shape of the recovery. What are we hearing or what are you hearing from companies, and indeed, what do you think? And related to this, there's increasing debate on inflation. Nowhere to be seen at the moment, given the rapid slow down in the global economy, but some sensing it around the corner, either given the stimulus that we've seen or cynicism that it's the only way for governments to reduce the debts that they're rapidly piling up. How do you see the shape of the recovery and how do you see that debate on inflation?
Devan: Again, it's another one of these very complicated issues. Because if you are talking to the economists, most, I think, would probably be erring on the side of a protracted recovery- so drawn out recovery- and the concerns of a second wave in terms of the rise of infection rates. Again, there's the issues around potentially permanent damage being done to the economy as a result of the lockdown. Then of course, as we've been talking about earlier on, there's a various impact of the change in consumer behavior.
When you speak to the economists, certainly there is this expectation that the recovery is going to be drawn out. In contrast, if you look at what's happening in the market, the market does not seem to think that. The market seems to be pricing in a faster recovery. We've seen quite a sharp rally from the lows of March. In addition to that, lower interest rates for longer, which similarly helps with valuations for companies because discount rates come down. So the market seems to be anticipating this stronger recovery.
Now that might be because the initial findings that we're seeing from lockdown easing, in the countries that have done it, shows that to recovery rates are coming through a bit better than expected, but I would then go on to perhaps temper that. China, which has been the first to go into the lockdown and emerge from it, saw quite a quick recovery or bounce post-lockdown easing but that gain is slowing. And we're certainly not back to the levels to pre-lockdown.
The second thing that markets need to be thinking about is that the prospects of a vaccine or indeed some sort of herd immunity seems to be closer than not. We've gone beyond worrying about death rates, as terrible as that might seem, to worrying about the economic consequences of lockdown. So markets are rewarding companies or countries that are reducing their lockdown measures. What does that mean? That means that we potentially have prospects of a market rally being funded by hope rather than actual data. That's something we need to monitor very carefully.
Then that leads to your inflation question. One of the things that quite clearly we've seen is the absence of inflation effectively since the global financial crisis. There is a real risk that inflation perhaps starts to return. The calculus on this would be that the governments around the world, particularly in developed markets, have piled on all of the debt to try and support their economies in this lockdown period, and as a result would welcome some inflation to help erode that debt. If you've got low interest rates, if you've got a focus of- by policy on fiscal stimulus funded by QE, and if you think about the issues of potential de-globalization, which is where there is the onshoring of supply chains; then potentially that increases costs and further adds to this inflation problem.
Now if that's the case, then we have a lot to think about in equity markets.
Richard: Indeed. Then in terms of that piling on of that debt, Devan, obviously some particularly developed countries have been the vanguard of that piling on of debt to protect their populace and to fund the healthcare outcomes that they desire. Other countries have piled on less debt. Do you think we'll get to a point where those who've provided- or who piled on less debt will be rewarded going forward relative to those who are left with that burden?
Devan: I would like to think so. I would like to think that there is a benefit to being relatively prudent in terms of your expenditure and the increase in debt. I suspect what you'll see instead is whether or not the rating agencies and indeed local investors are more than happy to take that increased debt risk going forward. I do think that when you make some sweeping statements or make some easier comparisons, there are quite a few emerging market countries that are going to come out of this with actually relatively strong fiscal and sovereign balance sheets, vis-a-vis many other developed market counterparts. Potentially, that might be a good thing.
Richard: Turning to Flavia. Devan touched on of where different countries and different regions are in terms of the virus and their management of it. China is being seen as first in and first out. You're sitting in Singapore, which was again early in but has seen second waves, but then there are other countries around the region, countries like India, where we're seeing fairly significant spikes and progress of the virus. How are you seeing the development, particularly within the Asian region?
Flavia: Richard, this is my fourth month working in a split team and working from home. I've forgotten what the office looks like. The impact of COVID and the way each country has emerged out of it really differs. The first in and out has been China. We're beginning to see positive numbers coming out of the companies. As Devan has alluded, the numbers might not be as strong as it was pre-COVID, but we are seeing a recovery and that is positive. It gives the market encouragement that the rally is somewhat substantiated.
On the other hand, we have countries like India, which is still recording about 9,000 new cases each day, and this is for a 5th day but yet within India, there is a big variance in terms of how COVID has taken place. There are 137 provinces, each of them divided into three zones, and some of them are already in green zone. Which means that the number of cases; the curve has flattened. However, you are beginning to see the impact on the economy in terms of the restriction on interstate travel. In part, I think COVID has also masked some of the underlying pressures that have been in the economy even prior to it occurring, which have been structural issues in some of these countries.
India is a good example. The debt burden for India has increased, especially after they have had to put in fiscal stimulus to support the economy. This is also true of Indonesia, which also suffers from a twin deficit. However, India also has fundamental issues in terms of its financial sector and perhaps COVID, or the impact of COVID, will then hasten the Central Bank to take more decisive measures and also be able to support persistently weak private sector investments.
While the macro for India and perhaps Indonesia remains less attractive perhaps to China, but on the stock level you're beginning to see some companies with very strong moat that are able to come out of this much stronger. They will be the consolidator in the sectors where the weak ones struggle amidst the inability to get financing from banks.
That's where I think it plays to our strength as stock selectors, having followed these companies for a while and having done all that work on the balance sheet, that we should be able to stick with the winners who while might suffer as the markets go through a volatile moment, over the next two to three years will emerge as compounders.
Richard: Do you think countries like India and Indonesia are doing a better job as regards managing the virus than, I suppose, we sitting in the West often think? Are they doing as good a job as they can, given the circumstances and the finances that the countries find themselves and have?
Flavia: I think they are doing the best that they can. The health system obviously is not as well advanced as it might be in some of the developed countries. Just the mass of people and the population intensity makes it pretty difficult in terms of trying to control. But in putting through measures to ensure that you control the movement of people, I think that is key to stopping or having that curve flatten. Then you have to balance that against the impact on economies.
In Indonesia, for instance, they are coming out of the lockdown, but yet the numbers are creeping up and you have to balance between the impact on mortality and the impact on the economy. Some countries simply cannot withstand that shock to the system.
Richard: Turning to you again, Devan, on the subject of ESG and it touches on some of the comments that Flavia made. There are schools of thought that talk to an acceleration in this area, but there are other schools of thought that talk to it as an expensive luxury that in many countries will no longer be affordable. I suspect that your view lies in the former, but it'd be interesting to get some color on whether this is one of the trends that you think might accelerate.
Devan: My view is that ESG accelerates from here. If you break it down into the different components of Environmental, Social and Governance, what you'll see is that as governments take a bigger role in markets and economies as a function of the spend that they're doing to keep these economies going, many governments will take the opportunity to try and tackle some of the environmental problems; climate change and the like. In places like Europe, for instance, will probably be accelerated with big government expenditure or packages to try and drive that. I expect to see similar things in quite a number of the large economies, such as China.
If you look at it from a social perspective, that's a really interesting one as well because I think historically that hasn't been focused on too much. One of the things potentially going forward is that if companies in particular are going to be bailed out by governments in this lockdown period, then there will be an increasing scrutiny of companies to make sure that they're doing social good. So companies that aren't doing that are potentially at pretty high risk.
Then I suppose with regard to governance, I mean that's always important but I think one of the things that we'll see is just increasing regulation. As a consequence of that, companies will need to ensure that they have the right governance in place to ensure that they meet all their requirements and the increasing requirements placed upon them.
I think ESG overall as a theme, if I can, will continue to accelerate and increasingly be a driver with regard to how people price companies in terms of what they're willing to pay for companies.
Companies with better ESG would do better than companies with poor ESG. You'll also see some really big government-led initiatives taking off, which will further drive ESG-type benefits.
Richard: Does that mean more sustainable companies better equipped to cope with the bumps in the road that we see and for the long-term, or does that mean lower return for shareholders and a greater return for a widening list of other stakeholders?
Devan: I think it's going to be a mix of both, to be honest. I suspect what we will see is a lower return overall for shareholders. That is something we will need to get used to. That said, those companies which are doing a better job with that, and certainly adopting more ESG-type focus, will probably be better performers than companies that don't. So there's still significant opportunities to make money. The point about the wider stakeholder base I think is absolutely the nub of it. Companies will need to think about the wider stakeholder base as opposed to just perhaps a more narrow shareholder base. I think, ultimately, that's probably no bad thing.
Richard: I wouldn't disagree. Flavia, from an Asian perspective, those ESG trends; similar to the global perspective that Devan is outlining?
Flavia: Yes, I think it will be pretty similar, but perhaps the adoption might be not as rapid as it would be in the developed countries. Because I think the focus for many governments remain growth or coming out of recession and having sustainable growth. The dislocation for many economies, particularly with respect to employment and small/medium-sized enterprise, has been huge. The key focus for most of the countries in Asia is to get back on track. I would think that ESG would be an occurring theme, but perhaps not clearly the core focus in the near-term.
Richard: Devan, you touched on globalization earlier. Obviously, we're in the midst of increasing disagreement between the US and China. I suppose, on one hand, the answer to the virus probably talks to more cooperation and globalization. Whereas on the other hand, the relationship between US and China is talking to less of it. How do you think that will balance? And I suppose that touches on some of the areas we've been discussing on ESG as well.
Devan: I certainly would like to think that as the world faces this global pandemic where everyone is impacted, the world would come together to try and resolve the issue. I think what we're seeing, in fact, is actually the opposite and it will accelerate the more protectionist leanings that have been emerging over the last few years. Deglobalization- i.e., the rolling back of globalization- will certainly be one of the key themes that we will need to think about and anticipate.
At the one level, you have, of course, the US-China disagreement and the attempts by the US to restrict technology transfer and the like to China. As a result of that, you'll probably see supply chains for technology change and that has some far-reaching implications.
Also, you will see that one of the immediate responses from the pandemic was the fact that most of the world's pharmaceuticals are produced in one or two countries. The reliance on that has been seen as dangerous and; therefore, potentially see the onshoring of that. In addition to that, as governments spend money to try and stimulate their economies, they will want to make sure that that money is being spent in their economies. So potentially, companies to benefit from that are going to have to move their factories of production or places of production to those countries. I suspect you will see an acceleration of a deglobalization trend, which ultimately is inflationary because it means that you're not doing it as efficiently as possible; and therefore, as a result, potentially costs go up, which feeds too into higher inflation.
Richard: Do the populace of the countries that are going to have to suffer this inflation, eventually they request a re-instigation of globalization and better cooperation between countries over and above their heads with their politicians?
Devan: Eventually, but I suspect that will take quite some time. Because in the short term what you'll see is that potentially wages will go up as production moves back onshore. It might be perceived as a very positive thing but, ultimately, my view at least is that isn't- it is inefficient and, therefore, not a great thing.
Richard: Flavia, maybe just finally, just turning that to you as, I suppose, some of the biggest beneficiaries of the offshoring and the globalization have been Asia generally, China in particular. We can hear what the politicians are saying, but obviously those on the ground are the ones who are going to be losing their jobs in the back of these global themes. Is there anything we're hearing from companies in Asia in this regard?
Flavia: Richard, I think that the general perception is that China has been a key beneficiary of offshoring. While China has been a beneficiary, some of the core beneficiaries have been the other Asian countries. Singapore is a very good example; that we're heavily reliant on exports and financial services and the open economy has been the way we have prospered. The same has been for Korea and Taiwan. Onshoring has tremendous implications for many of the companies that operate in Asia, in terms of where the need to relocate certain of their manufacturing activities. What's hogged the headlines of late has been TSMC, which has announced that it will set up a foundry in the US; something that it has long said it was not economical. So companies have to think of the way that they operate and countries need to rethink in terms of their reliance on manufacturing and exports.
I think that a pretty good article in terms of the challenges that Asia faces has been a recent article in the Foreign Affairs that's been written by Lee Hsien Loong, which is the Prime Minister of Singapore that is entitled The Endangered Asian Century. That if this conflict with China does not come to an easy resolution, the rest of Asia would be losers. It would be pretty sad to see, but we will really have to think about how many of these countries such as Singapore will need to reinvent themselves in the new world.
Richard: Interesting, Flavia. Sadly, that is all that we have time for today. Flavia, Devan; I appreciate your reflections on unusual times but within that; on styles, on the landscape, beyond the virus, the potential shape of the recovery, potential inflationary impacts after the recovery, the potential course of the virus, and then the broader topic of the ESG, and indeed the relations between the US and China, and offshoring and onshoring. I look forward to speaking again when perhaps we'll have a little more clarity on some of the issues discussed. But in the meantime, Devan, Flavia; thank you so much.
Devan: Thank you.
Flavia: Thank you.
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