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China, North Korea And Other Reasons To Be Cautious

Tom Burrroughes, Group Editor , August 17, 2017


An advisor firm in the US that focuses on ultra-wealthy clients says there are plenty of reasons at present for a conservative attitude towards risk.

China has a problem. Domestic investors who fear that the world’s second-largest economy might at some point hit the buffers lack a large market of safe-haven bonds where they can seek refuge, a situation that is only encouraging them to park money outside the country despite authorities’ attempts to thwart them, a US wealth management firm argues.

“The one thing that China isn’t developing fast enough is risk-free assets,” Andy Hart, managing partner for Delegate Advisors, the US-based firm, told this publication in a recent interview.

The Asian giant has sought to curb capital outflows, but that is not always easy to do if anxious Chinese investors are looking for a low-risk bolt-hole for their assets, and only find those outside, Hart said.

A lack of home-grown risk-free assets - such as the vast US Treasuries market - also crimps the ability of the Federal Reserve, and indeed other central banks, to normalize interest rates after almost a full decade of ultra-low central bank target interest rates, Hart continued.

China does, in fact, have the third-largest onshore bond market in the world although in value terms it still trails far behind the US sector, and arguably that sector needs to expand. There are moves by Beijing to catch up with the US and other major developed countries in having a large, liquid market for government and investment-grade bonds. In early July, for example, wealth managers welcomed the rollout of Bond Connect, a Hong Kong/mainland China bond dealing link. (In contrast to the equity market links that have been introduced in the past two years or so, the Bond Connect will only be open to northbound flows at the start, as the government tries to control capital outflow risks.) Recent data (source: Aon) shows the total value of outstanding bonds in China reached $9.4 trillion at the end of March, with the US at $38 trillion and Japan at $13.9 trillion. Total Chinese bonds in issuance grew by 29 per cent in the in the last year.

Hart’s comments about the - so far - lack of major risk-free asset markets in China came as he set out cautious investment views. Delegate Advisors, which focuses on ultra-high net worth clients, is wary of risk at present, concerned about issues such as around North Korea, Hart said. “We have told every client that North Korea is going to be a major issue, and we [the US] may have to act pre-emptively if China does not exercise its considerable influence over North Korea. There is no way to tell how this will all end at this time.” Hart said.

“We are telling our clients that they should prepare for market volatility around this situation.”

In fact, there could be a “pullback in equities,” he said. “Besides the North Korean situation, our caution regarding equities also has a lot to do with the rise in Chinese debt levels. The Chinese debt/GDP ratio is over 200 per cent now,” he continued.

At home in the US, valuations on US equities, such as shown by the Shiller CAPE Ratio (based on the S&P 500 Index of US equities) are at high levels; the CAPE Shiller Ratio is over 30; the mean level is around 16. In such a situation, only specialized types equity may produce genuine value, Hart continued.

In this situation, there remain opportunities in select areas of private real estate and secondary private equity; there is sense in keeping some “dry powder” on the side, with asset allocation to equities at the lower end of strategic ranges.

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