If the West is going through ‘Japanification’ what are the implications from an asset allocation perspective? For Allison Hill, director of investments at the $85.7 billion QIC, looking at what investment strategies make sense in a Japanese-style economy is a practical step when faced with low rates (many close to zero), low growth and no inflation.
“It’s a genuinely challenging time. It is not the same as it was before so you need to think about how the play book needs to change to manage for long term risk adjusted returns,” Hill says.
“Growth is quite muted, so the question is, how do you invest in this environment given current interest rates and valuations?” notes Hill. She views Japan as a potential model of what could happen to the bond market. “We think there could be a scenario when the world will become like Japan so we need to understand the implications for asset allocation in a total portfolio context.”
Like most investors, QIC has traditionally taken a benchmark-aware approach to bonds. But with a big part of the world delivering negative real yields, and with interest rates approaching the zero-lower bound, Hill is tasked with working out what that means for the fixed income allocation within a portfolio.
“We hold fixed interest for diversification and defensiveness so we have to make sure that portfolio continues to have those characteristics,” she says.
To that end, the investment specialist is carrying out a major research project on the fund’s bond allocation. The analysis essentially constructs the underlying exposures for a Japan-style environment where returns are at historic lows and will stay there for some time.
A work in progress
The analysis has thrown up some interesting questions.
“How effective is fixed interest in an equities selloff?” she asks. Will we see the same level of defensive characteristics historically witnessed from bonds? What is the forward-looking return profile and expected volatility and how do you manage this in a portfolio seeking diversification? And, if you take away benchmarks, what is the optimal basket of exposures to hold to provide you with the characteristics that you are looking for from your fixed interest return?”
The project is still a work in progress but Hill can say with confidence that the overarching approach will be to manage risk, or target a level of risk that clients are comfortable with. She stresses that it is not about chasing returns and taking excessive, and potentially unwarranted levels of risk. “Our approach is to diversify sources of return and get equal risk from both bonds and equities.”
In seeking diversification, Hill continues to seek out other suitable returning opportunities such as Chinese corporate bonds. Here, QIC is tapping into the local resources of Ping An Asset Management.
Despite her immediate focus on the potential for ‘Japanification’, Hill is looking beyond this period of near-record low rates. “In the long term, we believe that we will see inflation re-emerge. Therefore, investing in real assets, which will perform well in this environment, is a sensible strategy, compared to the recent playbook has rewarded being overweight in financial assets.”
While the majority of local super funds have sought to maintain unlisted exposures, she says there are a number of investors who have stayed overweight in equities because of the support provided by quantitative easing.
“This has been a profitable strategy with equity markets hitting recent highs,” she says.
Looking forward, Hill thinks a broader approach is important as interest rates head towards zero, making it harder (although not impossible) for the central banks to provide the same level of support to the listed markets.
She is hoping to see the Australian and international governments undertake prudent and targeted fiscal policy, since there is a limit to what monetary policy can solve given current settings.
A policy mistake
Hill says central banks around the world have looked at Japan to understand whether fiscal austerity was a policy mistake and that using fiscal policy to stimulate growth is perhaps a better outcome.
“If they do accept this, you will likely see opportunities in real assets which if growth and inflation pick up, should lead to a good environment for unlisted assets such as infrastructure,” she argues.
Fiscal policy is a big conversation topic right now and Hill can already see moves by both China and the US to build more infrastructure in efforts to stimulate their economies.
This activity definitely appeals. QIC’s infrastructure team has recently acquired a stake in Brussels Airport, which Hill sees as a strong long-term investment for the portfolios.
QIC’s allocation to unlisted assets varies across funds depending on their risk and liquidity requirements. That said, they are core parts of the strategy for each of its funds with the majority having exposures of between 10 per cent and 20 per cent to property and infrastructure.