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Return-to-Risk: Global Equities & Chinese Equities

Key Terms: Low-Interest Rates, China, Growth, Equity Risk Premium

Key Sources: Oaktree Capital Partners, CaiXin, Wall Street Journal, Others


"Under an ultra-low rate market environment for at least the next 24 months, investors seeking superior equity premiums would need to broaden their search for alpha new opportunities."

The risk to return table below is a good reference point to start off this article.


As commonly known, a flat slope signals a bullish investing environment and likewise a steep slope indicates that there are more bears than bulls. Throughout the past few months from our observation across the media, analyst reports and business counterparts, we discovered how the general focus was kept towards the discussion around: "if under a QE environment, how much flatter could the slope get?" and "when would this slope start to turn steeper?"


We believe this is the wrong angle to approach this issue. The more logical way to explain the recent rebound of equity prices is that the risk to return curve simply shifted down in response to the central bank's rate cuts. As prospective returns for all financial assets dropped to historical lows, investors scramble to seek alternative wealth storage instruments that are able to uphold a growth rate similar to their prescribed risk premium.


Referring back to the chart, government bonds and fixed income assets simply fail to offer an attractive enough premium, thus we see equities (especially those included in major indices) as becoming the "next best bet." In the current cash abundant market environment as long as companies are able to maintain a 2%~4% earnings yield, their share's would remain in high demand. To an extent, with more investor's entering the equity market, historical high P/E values attached to some stocks could be justified. Yet to what extent have investors taken into account that this new shift in asset allocation guarantees lower yields remains uncertain.


With plenty of cash and too many expensive deals, most investors would seek alternative investments. This leads to the question:" how much risk am I willing to take for an extra 1% of growth?" Venture capital is out of the question while LBO's might be worth a look their lock-in requirements would severely impact an investor's portfolio liquidity (something investors would seek to need in terms of future uncertainty).


Right now, looking across the horizon of assets, international equities, especially Chinese equities might just be the most logical asset for an investor to add into his portfolio. China's 3rd quarter GDP rose by 4.9%, consumer spending is backup to pre-pandemic levels and most importantly the official cash rate is at 2.2%. (Signalling a much higher-positioned risk-to-return mandate)


China's GDP for 2021 is expected to growth at 8.5%, taking the factors above into account, for 2021 alone, the average Chinese equity investor should be aiming for a 10.7% (Rf + Re) benchmark return. From a cycle viewpoint, China's growth remains robust and the central government's incoming dual circulation policy could only act as a catalyst factor for even greater growth.


For more on Chinese equities please click here


We'd like to reinstate that macro factors remain a factor of low significance in ACH's investment mandate and that we prioritise business value over anything else.


Disclaimer

ACH recommends that you seek independent Financial and Tax advice prior to making any investment decisions, you should not review this document as investment advice. The forward-looking statements included in this document involve subjective judgment and analysis and are subject to uncertainties, risks and contingencies, many of which are outside the control of, and are unknown to Aroau Capital Holding Pty Ltd. Actual future events may vary materially from the forward-looking statements and the assumptions on which those statements are based. Given these uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The information in this document is not investment advice and does not take into account the investment objectives, financial situation and/or particular needs of any prospective investor.


Key Things to Look out for


  • Will the popularisation of Chinese equities occur over the next few years?

  • Will the market absorb the negative sentiment behind future low earning yield?



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