I’m Kevin Barr, Head of SEI’s Investment Management Unit. Stock markets are showing a level of volatility that is extremely concerning to many investors. With that in mind, I’ve asked John Lau, Portfolio Manager for SEI’s Asia Pacific and Emerging Market Equities portfolios, to join me today.
I know it’s getting late in Hong Kong right now, so I appreciate you joining me. You’ve been right in the center of the storm, beginning with the protests in Hong Kong, and then the coronavirus and now the difficulties in the financial markets.
I’d like to start by asking you what you are seeing from Hong Kong.
You are right, Kevin. It’s been challenging where I am, beginning with high profile protests in Hong Kong nine months ago, then the coronavirus that has devastated the city’s economy, the Asian region, and now the world. The outbreak started in China at the beginning of the year, China has since taken a tough stance in containing the virus. Hong Kong reacted strongly as well. At this time, we are seeing some encouraging signs that the situation appears to have stabilized not just in China, but across Asia as well. Retail businesses and factories are gradually recovering, but it is nowhere near normal at this point.
How the current market conditions are impacting our portfolios.
Clearly there is a high degree of flight to safety in the markets everywhere. When there is panic and the U.S. dollar strengthens because it’s perceived as safe haven, it’s never good for equity markets in developing economies because foreign capital usually flows out. We are seeing significant selling pressure in most markets, but particularly when the markets have higher exposure to energy such as Russia and Brazil. Ironically, even though China has been struggling with the virus the longest, its equity market was hurt much less than other emerging market countries, particularly in Banks where the larger State-Owned Enterprises were perceived to have less risk. Its Internet-related stocks also did not fall as much due to their quality characteristics. Since our portfolios are diversified, our exposures in Russia and Brazil were cushioned by our exposure in China, but the selling pressure has been strong in recent weeks.
How are the portfolios positioned for the eventual rebound?
We have positions within our portfolios that are particularly sensitive to take advantage of the eventual rebound when the virus situation subsides. While we have holdings in the so-called New Economy stocks in information technology and telecom services, we also have selective holdings in financials, industrials, and energy across various countries that we found to be attractive based on fundamental valuation and their potential upside when the markets recover. In addition, we also have some smaller cap stocks and even a minor exposure in frontier markets which we believe could generate nice returns when market sentiment improves.
John, where do you see opportunities in the market?
Stocks that have higher sales growth have done well in recent years, even when you take into account what happened in the past month. But many stocks with attractive valuations but may not have high revenue growth have not participated in the prior market rally. At the end of last year, we noticed the market began to shift toward those types of stocks, particularly in Industrials, finance, and materials, but the trend was suddenly disrupted by the fear of the coronavirus. We believe once the current crisis moves on, investors will once again focus on fundamental valuation and the sectors I mentioned might benefit.
Do you think this time is a good time for active management?
Emerging markets have always been more challenging in information flow, accounting quality, and governance structure than major developed markets, so active management is a good way to take advantage of such market inefficiencies. As an example, the domestic equity market in China is rapidly growing and it’s not sensible to take advantage of it through index funds since there are a lot of “Old Economy” stocks such as energy and State-Owned Enterprises versus technology stocks and medium-sized businesses. Small-cap and frontier markets are highly inefficient as well. These are areas that active management can add value, and it is especially true when there is a major market dislocation such as what we are experiencing now.
Thank you John.
Glossary of Terms:
Alpha source: Our strategies are designed to capitalize on long-term drivers of market performance through exposure to persistent sources of returns such as mean reversion, trend-following and stability. We have refined our approach to identifying these alpha sources and the factor groups we employ as proxies to measure and capture their performance.
- Momentum Alpha Source: The investment manager seeks to benefit from investor under-reaction—due to anchoring. Such groups of stocks trend in price as perceptions change directionally and serially with incoming data, leading to herding behavior by investors.
- Stability Alpha Source: The investment manager seeks to benefit from investor tendency to undervalue lower-risk, higher-stability businesses—resulting from a focus on short time horizons and overconfidence in forecasts for momentum-driven stocks. Stability-oriented stocks have the power to exceed market expectations by consistently outperforming (rather than reverting to average market returns) and through the power of stable, long-term compounding.
- Value Alpha Source: The investment manager seeks to benefit from investor overreaction—resulting from aversion to loss. Such groups of stocks revert to the mean, as fear over the perception of the investment’s risk dissipates.
Basis point: One basis point is equal to 1/100th of 1%.
Beta: Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
Correction: A correction is a decline of 10% or greater in the price of a security, asset, or a financial market.
Correlation: Correlation is a statistic that measures the degree to which two securities move in relation to each other.
FAANG Stocks: FAANG stocks are Facebook, Amazon, Apple, Netflix and Alphabet (formerly Google).
Price-to-Earnings Ratio: The price-to-earnings ratio is the most recent price of a security divided by the company’s annual fiscal year basis earnings per share. Price to book ratio is the most recent price of a security divided by the company’s annual fiscal year basis book value per share.
Standard Deviation: Standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is for educational purposes only.
The S&P 500 Index is an unmanaged, market-weighted index that consists of the 500 largest publicly traded U.S. companies and is considered representative of the broad U.S. stock market. The Russell 1000 Growth Index measures the performance of those Russell 1000 companies with higher price/book ratios, higher predicted and historical growth rates. The Russell 1000 Value Index measures the performance of the includes those Russell 1000 companies with lower price-to-book- ratios and lower expected and historical growth rates. The Russell 2000 Index includes 2000 small-cap U.S. equity names and is used the measure the activity of the U.S. small-cap equity market.
Index returns are for illustrative purposes only and do not represent actual investment performance. Index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Investing involves risk including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments. Narrowly focused investments and smaller companies typically exhibit higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.
Diversification may not protect against market risk. There can be no assurance that goals will be met.