Seven burning questions from our investors on our portfolio strategy

During our quarterly portfolio webinar and sharing of market views, we received multiple questions from our clients regarding our positioning, views, and portfolio construction.

Here are seven questions we collated that received the greatest interest (and our answers):

1) Any thoughts on China’s recent rally considering the recent move to cut back on China exposure across the portfolios?

Despite the emerging bullish consensus for Chinese equities, we prefer to remain cautious as there are reasons to believe that the recent rally may not last. China equities have rallied on the reopening story and we think a lot of optimism has been priced in. This has opened up doors for a potential correction as negative catalysts are beginning to build. We see escalating risks of disappointment in China growth data and rising US-China tensions, both of which may threaten the rally.

China’s reopening is ill-timed. The dismantling of its zero-Covid policy comes at a time when the rest of the world is slowing down. As such, China’s exports will likely face headwinds in the year ahead. Consumers will have to come out in full force to spend in order to pick up the slack left behind by its exports industry.

At this point, it remains unclear if consumption will indeed rebound strongly, as battered consumer confidence, chronically high youth unemployment, and a lackluster property sector may hold back China’s consumption, leaving investors disappointed as the nation’s growth may fail to optimistic expectations.

There are also longer-term structural issues to worry about. We expect China to accelerate its shift to a top-down state-controlled economy. As the balance of priorities shifts towards self-sufficiency instead of economic growth, this may result in a low-growth period. The long-term profitability of private companies are also at risk, especially those that are not aligned with the government’s policy direction. China’s foreign policy stance will likely be more assertive, with President Xi steering China away from reconciliation with the West and increasingly adopting a harder line on Taiwan.

Given our view, we have reduced exposure to China / China-related equities and fixed income segments – i) we have cut our allocation to Chinese equities from overweight to neutral, ii) cut our allocation to Asian high yield bonds from overweight to neutral, given its high exposure to China high yield bonds, and iii) exited our exposure to Hong Kong-listed banks (via the ChinaAMC Hong Kong Banks ETF) within our tactical allocation sleeve.

Chart 1: Earnings forecast and price performance of the MSCI China Index

Table 1: EPS and upside projection for the MSCI China Index

China (MSCI China Index)	FY2022	FY2023	FY2024
PE ratio (X)	13.4	12.9	12.1
Projected earnings growth (YoY %)	-5.1%	3.4%	6.8%
Projected Earnings Per Share (EPS)	5.4	5.6	5.9
Target fair price (Based on 10.0X Fair PE ratio)	-	-	59.4
Potential upside (%)	-	-	-11%
Source: Bloomberg Finance L.P., iFAST Compilations. Data as of 23 Feb 2023.

2) What was the reasoning behind the inclusion of ASEAN equities in the portfolios?

Considering our negative view on Chinese equities and Asia ex-Japan equities, we have sought to reduce China-related risks in our exposure to Asian equities. ASEAN equities fulfils this and, on aggregate, are a more resilient expression for Asia. We have therefore initiated exposure for ASEAN equities in our tactical allocation sleeve, replacing the ChinaAMC Hong Kong Banks ETF.

We expect stronger growth in ASEAN this year as compared to major developed markets (DM) like the US and Europe. There are several reasons to believe in ASEAN’s growth resilience. First, a supportive commodities outlook should help to buttress export revenues for the region, while export volume softens as global growth slows. Second, we expect ASEAN tourism to climb throughout this year, supporting the region’s growth, especially for tourism-dependent economies like Thailand and Indonesia. Third, we expect ASEAN to face milder inflation headwinds relative to many economic regions in 2023. This means that ASEAN central banks could potentially adopt a less hawkish stance this year compared to Western DM peers, which could be less damaging to the region’s growth and equity performance.

Compared to Asia ex-Japan, ASEAN equities have a lower correlation with China (around 25% lesser) but a similar correlation with key equity benchmarks like the MSCI AC World Index and the S&P500 Index (Chart 2). We observe a similar trend if we look at betas – the beta of ASEAN equities to a Chinese equity benchmark is almost half of that of Asia ex-Japan equities. A lower correlation and beta imply that ASEAN equities allocation are likely to come with lesser China-related downside risks.

Furthermore, ASEAN equities have also consistently displayed lower volatility compared to Asia-ex-Japan equities. The surge in volatility for Chinese equities since 2020 has directly led to greater volatility in Asia-ex-Japan equities, as China comprises the lion-share within Asia-ex-Japan equity indices. On average, ASEAN equity volatility is about 10% - 15% lower than that of Asia-ex-Japan equities, and almost 40% lower than that of Chinese equities.

The secular story of ASEAN equities is also highly positive. The region itself is a prime beneficiary of the ongoing shift in supply chains away from China. According to trade data released by the US, the greatest beneficiaries have been ASEAN countries like Cambodia, Vietnam, Thailand, and Indonesia. This is an ongoing trend that will likely unfold for years, and we are only at the early phase.

Chart 2: ASEAN equities have a lower correlation to China (around 25% lesser) but a similar correlation with key equity markets

Chart 3: ASEAN equities have consistently displayed lower volatility compared to Asia-ex-Japan equities, which was heavily influenced by China

ASEAN Outlook 2023: Bright spot amidst a tough environment for Asian equities

3) Given the house view of a recession in 2023, how will the portfolios navigate this challenge?

2023 is shaping up to be a recessionary year with high inflation and tight monetary policy. To navigate this backdrop, we have positioned more defensively over the past quarter. Across all portfolios, we have raised our fixed income allocation – once in September (by +2.5%) and again in December (by +2.5%) – and trimmed our equity allocation accordingly. Within our fixed income allocation, we have bumped up our exposure to Singapore-centric bonds and global bonds, both of which are of higher quality.

This comes as we increasingly find fixed income more attractive, especially the safer segments. Higher policy rates have pushed yields to levels not seen in a long time. For example, global bonds, which are often lower-yielding, are now offering attractive yields close to 4%, the highest in the past decade (Chart 4). Furthermore, higher quality bonds offer greater defense during a recession given a stronger credit profile and low volatility attribute.

While markets expect rate cuts in 2H23, this is a view not shared by us. We see little likelihood of rate cuts and expect the Fed to hold rates throughout the year. Thus, at the moment, we are in no haste to pivot to longer-duration bonds and prefer its short-duration counterpart given further rate hikes.

As an asset class, valuations of bonds have also turned much more attractive as compared to equities. We compare this by looking at the yield of global bonds relative to the earnings yield of global equities (Chart 5). This excess in yield has been declining, which implies lower value in holding equities relative to bonds, as investors are receiving less and less potential returns from holding equities which are riskier. This tells us that fixed income has become relatively more attractive and it is a good time to raise exposure.

Chart 4: Yields of global bonds have surged to decade highs over the past year

Chart 5: Global bonds offering significantly greater excess yield over global equities

4) With a potential US ban on Huawei, how will it affect the US semiconductor industry? Will it affect the portfolios with exposure to semiconductors?

Before the ban, US companies were still able to conduct business with Huawei by applying for an export license beforehand. If the Biden administration stops granting licenses for US companies to export to Huawei, it is equivalent to a total ban on the sale of US semiconductors to the company. However, we are not overly concerned as we believe the financial impact coming from the loss of Huawei as a customer should be minimal for US chipmakers as most do not have significant revenue exposure.

In particular, the VanEck Semiconductor ETF, which we use to gain exposure to semiconductors across our portfolios, only has a weighted average revenue exposure of 0.55% to Huawei. This is a considerable drop from the weighted average revenue exposure of 2.6% in 2019 when the Trump administration first took action against Huawei.

Table 2: SMH constituents have even lesser exposure to Huawei today

Company	Index Weight	Percentage Revenue Exposure to Huawei
Broadcom	4.98%	2.49%
Qualcomm	4.72%	0.89%
Intel	4.00%	0.34%
Analog Devices	4.45%	2.44%
NXP	3.62%	0.44%
Cadence Design	3.78%	2.43%
STMicroelectronics	2.73%	1.36%
Marvell	2.74%	0.88%
ON Semiconductor	2.31%	2.01%
Skyworks Solutions	1.47%	3.27%
Weighted revenue exposure to Huawei Jan 2023		0.55%
Weighted revenue exposure to Huawei May 2019		2.58%
Source: Bloomberg Finance L.P.
Data as of 23 Feb 2023

China as a whole accounts for approximately a quarter of SMH’s revenue. If there comes a day when the US government decides to restrict the sale of all semiconductors to China (an unlikely scenario), the share prices of US chipmakers are likely to take a hit, especially those with significant revenues from China. That said, the bans that have been imposed so far only target the sale of advanced semiconductors, and not all semiconductors. US companies have also demonstrated their willingness to work around the bans, a sign that they still value their relationship with Chinese customers.

As such, we are not too concerned with the news in relation to our semiconductor exposure in our portfolio. Our allocation across the portfolios to semiconductors (only in our Balanced, Moderately Aggressive and Aggressive portfolios) is around 1% - 2%, which is also unlikely to drag overall performance should the US chipmakers continue to react negatively. Beyond that, our position in semiconductors is anchored by a positive long-term view, driven by its growing application across secular trends such as 5G, internet-of-things, autonomous vehicles, and artificial intelligence.

5) What is your view on commodities? Will a recession impact commodity prices and your positioning?

While a recession will largely weigh on demand for commodities, we expect prices to remain elevated as supplies should remain tight amidst a volatile geopolitical backdrop and climate conditions. Furthermore, we think the economic crunch may not be as detrimental to commodity-related companies, which have strengthened their balance sheets and maintained fiscal discipline.

Energy prices went through a volatile 2022, and we are likely to see a repeat in 2023. Demand may shrink when a global recession hits, despite the buffer from China’s reopening. However, supply constraints, such as OPEC+ not increasing production aggressively and the practice of capital discipline in raising production, will continue to hold back supply. We expect oil and gas to remain stuck in a state of further shortages, with higher and more volatile prices.

For metals, the short-term outlook remains mixed. While China has reopened and economic activity has picked up, the weak housing market continues to weigh on the demand for industrial metals. However, in the long-term, we see the green transition as a major tailwind for the sector. For agricultural commodities, demand remains strong in spite of tightening crop supplies due to adverse weather conditions. This is keeping the short-term price outlook positive. Over the longer-term, climate change will likely put pressure on agricultural yields, with a tighter supply likely favorable for prices.

In our portfolio, the areas most sensitive to changes in commodity prices are our LATAM equity, EMEA equity, and global natural resources exposure (only in our Balanced, Moderately Aggressive, and Aggressive portfolios). With our view that commodity prices are likely to remain elevated this year, we are comfortable with our positioning in these areas at the moment. Moreover, LATAM and natural resources are areas in which we continue to hold a favorable view.

LatAm: A Compelling Emerging Market for Investors

6) Developed market equities have done badly last year. The portfolios have quite some allocation towards equity markets like US and Europe. Any concern about a repeat of last year’s poor performance?

While these two regions comprise around 40% of the equity exposure within our portfolios, the weight is much lesser than our equity benchmark, the MSCI AC World Index, which has a combined 70% – 74% weight (Chart 6). Our exposure is far less than our benchmark because our portfolios follow a GDP-weighted approach, in which regional allocations are based on the size of the underlying economies. On the contrary, the benchmark follows the more conventional market cap-weighted approach. Our exposure may seem high when viewed in insolation, but remains moderate relative to the benchmark.

Between US and European equities, we are more concerned about the latter and continue to hold an underweight position across our portfolios. Despite some relief from the energy crunch with the warmer weather, the macro backdrop for Europe remains challenging. The persistent inflation and lagged impact of rate hikes mean European growth will continue to be under pressure, while a softening global demand simultaneously weighs on the region’s highly-internationalised manufacturing sectors.

While the consensus sees Europe side-stepping a recession, we think it is too early to tell and even if this happens, stagflation awaits the region. Despite a decent 4Q 2022 earnings result thus far, corporate earnings and margins should also come under pressure this year as pricing power declines amidst high costs.

We have also adopted a Value-tilt for our US and European equity exposure by holding a mix of Value and Growth funds within these segments, with a larger weight allocated to the former. This inclusion has been beneficial for our portfolios’ performance. Last year, Value has largely outperformed Growth, especially in the US, as macro conditions, valuations, and fundamentals were supportive (chart 7). These factors should continue this year, supporting Value performance.

Value leadership is back – The shield against high inflation and policy rate hike

Chart 6: Equity allocation differences between MAPS portfolio and our equity benchmark

Chart 7: Value has outperformed Growth on a global level last year

7) When making changes to the MAPS portfolio, how does the team select the investment product? Using the funds available, or invest directly into equity / bond counters?

When it comes to product selection for our portfolios, we mainly use diversified funds (unit trusts and exchange-traded funds) to express our investment views. These products are available on our platform. Not only do they allow us to express our investment views, but they also provide a significant degree of diversification, minimising company-specific risks within the MAPS portfolios.

Our research team has been publishing the Recommended Funds Report and the ETF Focus List to help investors make informed decisions on investment product selection. These are a compilation of unit trusts and ETFs that we recommend across both the equity and fixed-income universe, covering global, regional, single-market, and sector-focused strategies. These products are selected based on a rigorous selection methodology, involving track record assessment, expenses, risk, and other qualitative variables (check out an outline of our process here).

Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

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Seven burning questions from our investors on our portfolio strategy

1) Any thoughts on China’s recent rally considering the recent move to cut back on China exposure across the portfolios?

Chart 1: Earnings forecast and price performance of the MSCI China Index

Table 1: EPS and upside projection for the MSCI China Index

2) What was the reasoning behind the inclusion of ASEAN equities in the portfolios?

Chart 2: ASEAN equities have a lower correlation to China (around 25% lesser) but a similar correlation with key equity markets

Chart 3: ASEAN equities have consistently displayed lower volatility compared to Asia-ex-Japan equities, which was heavily influenced by China

3) Given the house view of a recession in 2023, how will the portfolios navigate this challenge?

Chart 4: Yields of global bonds have surged to decade highs over the past year

Chart 5: Global bonds offering significantly greater excess yield over global equities

4) With a potential US ban on Huawei, how will it affect the US semiconductor industry? Will it affect the portfolios with exposure to semiconductors?

Table 2: SMH constituents have even lesser exposure to Huawei today

5) What is your view on commodities? Will a recession impact commodity prices and your positioning?

6) Developed market equities have done badly last year. The portfolios have quite some allocation towards equity markets like US and Europe. Any concern about a repeat of last year’s poor performance?

Chart 6: Equity allocation differences between MAPS portfolio and our equity benchmark

Chart 7: Value has outperformed Growth on a global level last year

7) When making changes to the MAPS portfolio, how does the team select the investment product? Using the funds available, or invest directly into equity / bond counters?

Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

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Seven burning questions from our investors on our portfolio strategy

1) Any thoughts on China’s recent rally considering the recent move to cut back on China exposure across the portfolios?

Chart 1: Earnings forecast and price performance of the MSCI China Index

Table 1: EPS and upside projection for the MSCI China Index

2) What was the reasoning behind the inclusion of ASEAN equities in the portfolios?

Chart 2: ASEAN equities have a lower correlation to China (around 25% lesser) but a similar correlation with key equity markets

Chart 3: ASEAN equities have consistently displayed lower volatility compared to Asia-ex-Japan equities, which was heavily influenced by China

3) Given the house view of a recession in 2023, how will the portfolios navigate this challenge?

Chart 4: Yields of global bonds have surged to decade highs over the past year

Chart 5: Global bonds offering significantly greater excess yield over global equities

4) With a potential US ban on Huawei, how will it affect the US semiconductor industry? Will it affect the portfolios with exposure to semiconductors?

Table 2: SMH constituents have even lesser exposure to Huawei today

5) What is your view on commodities? Will a recession impact commodity prices and your positioning?

6) Developed market equities have done badly last year. The portfolios have quite some allocation towards equity markets like US and Europe. Any concern about a repeat of last year’s poor performance?

Chart 6: Equity allocation differences between MAPS portfolio and our equity benchmark

Chart 7: Value has outperformed Growth on a global level last year

7) When making changes to the MAPS portfolio, how does the team select the investment product? Using the funds available, or invest directly into equity / bond counters?

Declaration:For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

Select Country/Region

Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.