Risk aversion in a changing world order
In recent months, intensifying uncertainty brought about by fears of a global recession, the ongoing US-China trade war, the probability of a hard Brexit, and unrelenting Hong Kong protests have been eating into the wealthy’s assets making them more risk-averse.
Although private banks and wealth managers say there is no cause for serious concern yet, many of their clients are getting worried about the impact of these events on their portfolios. The concerns have forced many of them to reassess their short-term investment strategies.
“There is a sense of caution that has increased in recent weeks. Much of this comes from political uncertainty driven to a large extent by tariff and trade-related issues that one has seen. The worry to some extent is also the yield curve inversion and signs of slowing growth in certain parts of the world which leads to talks of a potential recession,” says Bhaskar Laxminarayan, chief investment officer and head investment management Asia, Bank Julius Baer.
On August 5, for example, equities dropped by 3%, their worst loss of the year, after China countered US President Donald Trump’s tariff threat by halting purchases of US agricultural products and the renminbi dropped below seven to the US dollar.
On that day, the world’s richest billionaires lost US$117 billion, while ultra-high net worth investors (UHNWIs), with assets of US$5 million to $10 million or more, and HNWIs, with assets between US$1 million to $5 million, who until that time had experienced steady gains in their wealth, also experienced abrupt reversals. Although the stock market recovered quickly, the indices dropped again to another record low nine days later on the back of fears of a recession.
In Hong Kong, unrelenting protests and the resulting government crackdown have reportedly wiped out US$15 billion from the coffers of the city’s wealthiest tycoons since the protests began in June. Initially, the protests were against an unpopular extradition law. But it has since morphed to include a broader range of issues including the threat of lost civic and political freedoms, police brutality, and wealth inequality.
While most of these were paper losses, the ultra-wealthy are being reminded that they cannot control geopolitical events and that they have to review these events very carefully to avoid massive losses to their portfolios.
To be fair, UHNWIs and HNWIs are generally more sophisticated and savvy in terms of investment skills. They tend to watch their risk-return profile carefully, study long-term indicators, and turn to experts for advice.
But in recent months, the consensus has been building among these investors that a global economic recession is coming as a result of the confluence of geopolitical events and that they must be prepared for it.
Studies indicate that it can take about 20 months for a recession to become a full-blown event.
In the wake of such a scenario, many UHNWIs and HNWIs have been shifting their wealth from high-risk, high return assets to more stable but lower-yielding and highly liquid safe-haven assets. There is a general shift away from equities to fixed income assets as reflected in exchange-traded fund (ETF) flows. US equity ETFs had outflows of US$10.9 billion while international equity ETFs experienced outflows of US$5 billion for the week of August 8.
The shift to lower-risk assets is also reflected in the inflows to fixed income ETFs. About US$3.5 billion flowed into US-listed fixed income ETFs during the week of August 29 with year-to-date inflows standing at US$144.4 billion.
Another indication that UHNWIs and HNWIs have been shifting to more stable and lower-risk assets is the increased inflows to gold, which is traditionally seen as a safe haven asset. The SPDR Gold Trust (GLD) ETF saw inflows of US$1.2 billion for the week of August 29. For the year as a whole, GLD has now seen net inflows of US$4.4 billion.
When it comes to major currencies, both the euro and the pound sterling have weakened substantially, while, the US dollar has remained strong despite the trade imbalance and fiscal deficit. “These are signs of a classic, textbook risk aversion scenario,” says a private banker who manages discretionary portfolios.
With this kind of market scenario in mind, UHNWIs and HNWIs are saying “we need to be paid to hold investments.” For many of them, this means shifting their core holdings to dividend-yielding equities.
Anecdotal evidence indicates that in recent months, private bankers and wealth managers have been receiving instructions from their clients to allocate more to dividend-paying stocks as part of the core holdings for their managed portfolios.
“A lot of these dividend-yielding equities are still very much in the picture. We do run managed portfolios and this is one of our core holdings. Whether the market is up or down, these equities are evergreen and they’re happy to hold that,” says a senior banker who runs a multi-family office.
In addition to dividend-yielding equities, there is also an increased preference for structured products particularly those with a capital guarantee.
Such products generally feature capital protection to meet investors’ risk-aversion requirements while providing some return on investment upon maturity. These hybrid products are designed to weather the uncertainty and volatility of markets as well as provide some protection on the downside.
In response to increasingly demanding investor requirements, a lot of innovative structured products have been popping up in recent months with interesting features such as absolute return and airbag certificates.
But a common theme is that the UHNWIs and HNWIs are seeking structured products which provide decent risk-return profiles as a hedge against a sudden market downturn.
However, a big portion of their core holdings remains in dividend-paying equities as well as high-grade fixed income securities.
In the face of the uncertain geopolitical situation, UHNWIs and HNWIs are ensuring they have sufficient liquid assets that will allow them to withstand a recession when it comes.
Securities trading has been subdued with data from the Hong Kong Exchange (HKEX) indicating that market capitalization decreased 3% year-on-year to HK$32.1 trillion (US$4.1 trillion) at the end of July 2019 from HK$33 trillion at the end of July 2018.
The average daily turnover also decreased by 23% to HK$68.7 billion in July 2019 from HK$89.6 billion in July 2018. The average daily turnover of ETFs for the first seven months of 2019 also dropped 2% to HK$4.7 billion from HK$4.8 billion for the same period last year.
This is an indication that many investors are staying on the sidelines and holding on to their cash and liquid assets.
The big elephant in the room that is now being quietly talked about in the private banking and wealth management community is whether Hong Kong, in the wake of the protests, will continue to be the safe haven for UHNWIs and HNWIs that it has traditionally been.
The UHNWIs and HNWIs have clearly been caught off guard by the magnitude of the protests and the potential fallout. While no one has pulled the plug on Hong Kong yet, private bankers and wealth managers are now in discussions with their clients about various scenarios, prospects, and possibilities on how to respond to the situation.
Most Asian UHNWI and HNWI clients have their assets booked in either Hong Kong, Singapore, or both. Clearly every client has their own preference and reason for one city or the other.
But for many of the wealthiest clients, they have substantial assets booked in both cities as a means of geographical diversification even before the protests. For such clients, moving their entire portfolio from one city to the other will not be an issue in the event that they have to do it.
For the smaller HNWIs who are booked exclusively in either Hong Kong or Singapore, some are now seeking ways of improving their geographical diversification.
In addition, most of the UHNWIs and HNWIs are dual passport holders which gives them more flexibility in moving their person and/or assets when needed.
Most private banks, wealth managers, UHNWIs, and HNWIs are still optimistic that the Hong Kong situation will be resolved soon. After all, Hong Kong has been through worst crises in its history.
Parallels are being made with the 1967 riots when communist elements and their sympathizers attempted to subvert the British colonial government instigated by events in China. The rioting, bombings, and assassinations lasted 18 months and claimed 51 lives.
However, the reforms that were implemented following the 1967 riots paved the way for Hong Kong’s emergence as an Asian tiger economy and global financial center.
Among the UHNWIs and HNWIs, the events have also planted seeds of concern that the issues raised by the protestors, particularly the issue of serious wealth inequality, are not unique to Hong Kong but part of a global phenomenon that also exists in Europe and the US.
The world might be at a turning point right now. Lots of things are happening and all of these are affecting people’s investment appetite. It’s fair to say it’s now very subdued and risk averse,” says a senior private banker.