A High Level Overview of the Chinese Market [Chills 32 with Stashaway]
Investing is not just about stock analysis. Studying the economy as a whole, also known as the macro economic view also plays a critical role in your investment decisions. Does the US-China trade war affect the two countries only? What impact does inflation have on our portfolios and how should we plan for it? In this week’s Chills with TFC, we invited Freddy Lim, CIO of Stashaway to dissect these macro ideas in detail. This is definitely a must listen for those who are not so familiar with macro ideas!
Through Freddy’s insights and analysis into recent news on the US-China trade war, China’s internal regulations and more, listeners will gain fresh perspectives on these issues. While the media tends to portray these news in a negative light, Freddy reminds us that there are still good investment opportunities out there if we know where to look.
For those who don’t mind going deep and technical, you are in luck as Chills 32 also goes into how inflation and forex can affect your investments. Freddy and Reggie will do the work and break down the numbers for you so that you don’t have to. Take this opportunity to enhance your macro knowledge!
Reggie: Last week, we focused on the Chinese stocks from a bottom up approach, from their business fundamentals. This week, we are going to go from a higher economic level, macro economic view. They are very different strategies and I would say that many of your institutional funds and portfolio managers do take a macro level portfolio and location kind of strategy. If you hear words like “broadly diversified”, “macro economic regime”, “risk-parity”, these are all key words to know that your portfolio should be created from a macro level which looks at central banks, interest rates, global debt, bond yields, broad equity valuation, GDP (Gross Domestic Product) and all those kinds of stuff.
So if you have your money in something like that, today… probably will help you to give a better perspective of the current situation with the US-China trade war and all this legislative stuff. Welcome back.
Expand Full Transcript
Welcome to another Chills of TFC session. In this series, we want to bring out interesting, relevant people to have us learn better from various perspectives. Life is not always about learning from people that we already agree with. Perspectives shape a rounder thinker.
So in our pursuit of life we love while managing our finances well, our guest for today is the CIO (Chief Information Officer) of one of the biggest robo-advisors in the region. They are focused on an economic regime, macro-style investing and you have heard from him a few times. I’m happy to bring him on again to share with us his thoughts on how he sees China, specifically China-US relations, and China’s latest legislative run.
How does it affect his way of managing portfolios? Because he did say that he has changed his strategy in July 2021. From a risk parity, all-weather portfolio to an economic inflationary regime portfolio… a lot of big words, so I let him to share with you and I’m pretty excited to learn more from him. So welcome Fred on the show, Freddy Lim from StashAway.
Okay, we back… we back, live together with Freddy from Stashaway. For all of you that didn’t know, he hasn’t been out in the media circuit for a long time so thanks for coming on the show, Freddy.
Freddy: Hey, Reggie. My pleasure. You know, it’s always enjoyable to be on your show and so I’m looking forward to some fun.
Reggie: For sure. Recently, a lot of things are happening, so a lot of fun going on. I’m not sure if you can put it that way, but yeah, I think we are all going through some stuff and also the markets are going through some stuff. So any opening comments based on what is happening in the market at this current moment in time? You want to bring us through some thoughts?
Freddy: Look, it’s part of the market’s natural behaviour. You get the ups and downs and you simply have to go back to your financial plans and review a risk level of your portfolios and don’t get too excited always. This is all about planning.
Reggie: Yes, and for all of you that don’t know Freddy… I don’t know how you don’t know him… but anyway, for people that don’t know him, he’s a super big macro economic regime kind of investor, so very high level and we’re going to have that discussion today. So if you have any specific question… I do know that for more retail investors, these parts can be a little bit more technical. A little bit more complicated, economic factors and all that.
So if you have any specific question… when we are blabbering on, we’re having fun ourselves, and you don’t know what we’re saying, you can drop it in the comment section. I will try to dig it out and talk a little bit more about it.
Let’s go straight in. Recently, there’s been a lot of discussion with the US-China… there are many factors going on. Today, we are focusing on China, but China does not live in an Isolated world. There are many other people in this world and US-China trade war is probably the biggest factor so far that is not in the media circuit. It’s very underdeveloped in my view of what is being discussed. Everybody’s talking about Chinese regulation and we can talk about that later, but opening this discussion, I want to dig a little bit deeper into the US-China trade dispute and how this whole thing is playing out in your view?
Freddy: To start with, it’s still going on and…
Reggie: They say it’s no longer a Trump thing.
Freddy: It’s still going on and it’s not US-China only, it’s China versus the west. It has a lot of implications, including the regulation measures we’ve seen of late. It’s part of that overarching trade war, but it also leads to Chinese exploration to be self-reliant in terms of technological needs like chips, hardwares, robotics, even 5G networks. The end story to make it simple is that technological ecosystem of the future will be broken into two superpowers. It could be two ecosystems. All countries in the world will have to tread carefully between trying to service the two and not anger the other, because they are going to try to be [indiscernible] and reduce their mutual reliance and this is leading to a lot of things that we are observing this year.
Reggie: So… hearing the first talking point is that you think that the technological ecosystem will be split into two. It’ll be China versus the west, but I want to dig a little bit about the west. A lot of people talk about the West like it’s monolithic also, but actually the US leads the west at this moment in time, yes and probably more aligned will be Canada and Mexico, to be more exact. There’s a block there, but the EU (European Union), it’s a little bit questionable. So you want to help us understand why you think this one whole thing is a block and the whole UN Europe region still is leaning to towards the US?
Freddy: Well, if you look at the demand and supply, its sort of like China, US being the biggest in the room and they are importing services and they’re also exporting services. But because they are the two biggest guys in the room, you can see the European union as a block that’s trying to service either one, or both. They are their customers essentially and you can see already, the big network providers in Europe, they’re trying to steer very carefully between US sanctions and also appeasing the Chinese. So they are pragmatic. They know where they stand. However, the US and China is more in direct conflict than any other country.
Reggie: Okay… loosely you think it’s these two and Europe is kinda in the middle but more to the west in that sense. Okay, so then what do you think of China’s development with this whole technological separation compared to just being with the US? Because the discussion is, for a long time, the US has been the backbone of a lot of the big tech, whether is it GPS, whether it’s the internet, whether is it chips and all that stuff and China has been building on all those ecosystems and to you, it’s separating, and I think it’s the discussion out there in the open that there will be a decoupling of the tech or decoupling of the markets.
But how do you see this thing playing out in China? How is it going to play out? Because it’s not like we can just set up something immediately. So I wanna hear a little bit like how is it coming along? Maybe you are disagreeing. You think China can do it one, very easy?
Freddy: No, it’s not easy. It’s going to take some long-term commitments, but it present investment opportunities for investors because somebody more backward than the US in a particular area is building this up and the names in China is going to get government sponsorships, support, grants, maybe even blessings. So they are names that will come up and you already see it even in clean energy reform is not a US thing only, even China. You see the likes of NIO and all these electric vehicles companies are really getting momentum itself within China.
So you have a Tesla equivalent in China in the future. That’s kind of to be expected. There are opportunities if you care to look and if you do have a long-term view, there are massive opportunities. There are short term noise right now, but I know the question’s a bit long-term so I would go to the short term later, but it’s a long-term strategic initiative that you need to take when it comes to China.
Reggie: Okay. So you think in the long term, it’s gonna work out. China’s going to get itself sorted and it’s going to become a significant player in the global stage. Is that the premise yet that they’re working on?
Freddy: Maybe not global stage because they want to be self-reliant. If I have semiconductors, I want to have my own national champions in it. So I reduce my reliance on importing from US and Taiwan… TSMC (Taiwan Semiconductor Manufacturing Company), for example, strategically a problem. So I want to have national champions. I also want to have my own 5G networks to power these innovations better. Maybe even 6G… they’re talking about 6G already, and chips making obviously is related.
This very sort of input to other parts of the tech ecosystems, they want to have more say in it. Internet stocks is one thing, e-commerce are one thing, but this is going deeper into the underlying hardware and network that power all these things. So I think China is taking a very deep strategic look. The Five-Year Plan says it, the next Five-Year Plan will say it, the next next Five-Year Plan will still say it.
Reggie: Yes, definitely something to note. By the way, I just want to put it out there that 3G, 4G, 5G, 6G, they are different technology altogether. It’s not like an elevation of the same technology. It’s just a branding exercise, but it’s just being used too loosely. But anyway, China is leading in this whole connectivity, 5G development at this point in time.
So I get what you’re saying because the Chinese e-commerce ecosystem or the consumer ecosystem, the digital consumer ecosystem is probably a lot more ahead of other countries. It’s very well developed. But the network and hardware infrastructure is a little bit questionable. You can see that the Chinese government is trying to invest in it. So in the long-term, I think they would, like you said, they would do fine.
But you were talking about short term noise. Nowadays, there’s a lot of news information going around being very concerned about China’s regulation internally, China’s initiative. What are they trying to do? Are they trying to kill their own companies? Do they not want to fight the US? So can you walk us through like how are you seeing all these regulations and all these quote unquote, “short term noise”?
Freddy: I will go top down. First, the ramifications of Donald Trump’s trade war, one of them is the US now have this rule where the Chinese companies listed in the US, they must be open to supervision and audits. In those audits, they must be able to be demonstrating they are not under any foreign government interference and they have the right data protection and if they don’t, they have a 3 year window to address it before the de-listing happens. So that’s on the US side. There’s also the Chinese side thinking, “oh my god, my national champions are listed in the US”. The US can subpoena them for information that could be sensitive to Chinese national interests.
Both sides have the same concerns. So the whole debate about China now is that, details aside, the recent regulations surprised people. Because it surprised people negatively, they look forward to the next bad thing, whilst the Armageddon scenario. Would China ban VIE (Variable Interest Entity), which is a primary way for most China companies to actually list overseas? I will explain a bit more later. What if they ban it, and then all the stocks get delisted, they become private and investors get stuck… and this Armageddon scenario and this kind of fear. Because they were surprised by the education sectors measure. You naturally think about this risk.
This risk is however misplaced as I will get into the details later, Reggie, because like you said, I’m not going to kill myself. I’m not stupid. I want to put up a good fight. I want to just have a say about which companies should raise funds where. Maybe they should be in Hong Kong or some exchanges in China. We have enough capital in China, we have no lack of money. They want to have that say from the angle of national security, consumer data protection primarily.
This is the crux of it, before we go into the details exactly about all those VIE… I’m happy to go into it. But the overarching thing is that most people do not know in the last 20 years, most people invest in China but under Chinese law its illegal. The Chinese law… most companies are not allowed to have foreign ownerships, and the VIE is sort of the offshore company approach in Cayman. Alibaba used it, a lot of people used it and they sort of made it happen. The authorities turned a blind eye and allow it to happen for growth.
All they’re saying now is that “get my approval before you go ahead. I want to approve it.” The moment they approve it, it becomes legit for the first time ever in the history of Chinese financial market. VIE has a legit status because now it’s an approval process. So that’s all they’re asking. Banning it is never on the agenda. It doesn’t make sense. So delisting, because of the ban on VIE, because of Chinese policy directions, that is an armageddon risk that’s misplaced. That’s what I’m trying to put out here.
Reggie: Can you share with us a little bit why you think it does not make sense to ban it?
Freddy: You think about it, how it works is this. Let’s see how the VIE works. Actually Alibaba did it… so they set up a paper company in Cayman. It’s the VIE. The VIE had an arrangement with Alibaba at home that all economic interest in profit belongs to the VIE. Then the VIE goes to the US and work with the US bank and say “I want to list on NASDAQ as an American Depositary Receipt (ADR).”
So that’s why when you see Alibaba, the ADR has a price, and then in Hong Kong listing, they can do a secondary listing, that’s not a price is because of this reason. However, this structure is in the eye of the… it’s never been approved. They turned a blind eye. They never said it was illegal, but it’s not legalized either. It is a tricky catch-22 when investing in China.
Now, when China says “any new company want to list overseas or any assisting company who’s not affected anymore… but if you want to raise additional funds, you come to me for pre-approval. I want to be the one to decide whether you can raise in the US or you should come home”. It should be in Hong Kong or somewhere, but you need approval. And the approval… we’ll look at things like your data security, cybersecurity, national interests and so on.
The case of Didi was the most outrageous because they actually couldn’t stop Didi from going public, but they warned DD not to go public. So you see, they can’t even ban it. It’s out of the jurisdiction. It’s in the Cayman. This is misplaced because they cannot ban it. But what they told Didi was “don’t go ahead. You still have issues to iron out before you go there. Didi went ahead anyway and able to go ahead and what’s worse, in the same week of the 100th anniversary year of the Chinese Communist Party. What do you expect what happened? They banned them from the app store and all that retaliation.
Reggie: So you think that is a political thing?
Freddy: No, that’s a corporate bad behavior being punished. It’s not even politics.
Reggie: Okay, okay.
Freddy: That’s what I’m trying to say. Its totally disrespectful. Regulators have told you because it’s consultated, they told you do not go ahead. You went ahead and there’s the 100th year anniversary of CCP, so this is outrageous. Immediately after Didi, it triggered this clampdown of the education sectors, which for years got a lot of complaints. Parents are stretched with their budget and spending. Kids are stretched for time, never had any social life. It’s becoming a social problem when private capital, massive amount of private capital is in the social goods.
So they’re actually trying to address this. But the issue is not the policy, it’s just the PR or communication issue because it’s like… directives are set here. Every department wants to show that they’re doing something and started implementing policies and notices. It seems like a sweeping reform that was unintended. The market will be the signal that the top were looking and “okay, hang on a minute. Something is wrong here, we need to do this better.”
This is what’s happening right now. China is consulting with the banks. Even China’s consulting with the US since the SEC (Securities and Exchange Commission) say “I don’t want any Chinese companies to list anymore in the US because of unclear policy implementations.” It’s good to see them talking because they care.
Lastly, one more good news is that they’re going to do fiscal stimulus again to try to buffer the economy. All these are coming in, so they do care. The national team will come in, the stimulus will come in, the policy may try to find a way to implement better, but they’re reacting to issues that’s been raised by consumers for many years.
Reggie: So in your view, two things, right? One thing is the Chinese government is merely just reacting to what the ground wants, and the other is that the VIE structure is in some ways in a process of being legitimized, so it’s not gonna disappear. In fact, in this whole saga, it shows that it’s here to stay.
Freddy: Absolutely. That’s exactly the crux I’m trying to say.
Reggie: Okay, pretty interesting. What is the kind of short-term reaction in the market? How do you read it? Of course, I know there’s a lot of fear and all that noise and all those things. But how will you feedback to the listeners what is this whole short term view of things? Why are people, in your words, very short-termism?
Freddy: First of all, the game spoiler was monetary stimulus. In the history of money in the last hundred years, most of the money is printed in the last one year because of the pandemic and we get spoiled because returns were very high last one year. The fact that to try to get people to buy dips is becoming psychologically a different thing because people are looking at all kinds of very inflated assets and they are chasing returns.
However, when you ask people, you interview them, without the noise and social media on, they would tell you they want to buy low sell high, but the actual act turns out to be buy high, hoping to sell higher. That eventually could be a problem when you know that in a boom market, it’s very common to see a correction of up to 20%. It comes randomly. Nobody can predict and then it just bounces back very quickly. This is the way the market detox and takes out bad players so that it can move forward healthier.
That is one of the thing that will come. It’s inevitable. What I’m trying to say is sometimes something with very strong long-term potential, in the near term there’s some headwind you got to think forward.
So it’s like… what do I mean by forward looking? In some retranslation, what’s next? You think about what’s the next bad thing that can happen, evaluate its consequence. You think about the next good thing that can happen, evaluate its consequence. If the ratio between the good versus the bad is a very high one, that’s a great long-term investment.
Most likely in this case for China is… the next good thing is taking medium to long term and it’s a huge one. The next bad thing is very short term, but its impact on the market is now getting smaller and smaller. You can tell by the price action. So the ratio is shifting in favour of the long-term investors.
That’s how I think about it. It’s very complex. It may sound complex, but this is the way the market function. It’s forward looking. That’s what we meant by forward looking. It means what’s the next bad thing in the near term? What’s the next good thing in the medium and long term? What’s the ratio between the two and then can I invest in the long-term? This is how it works.
More translation Reggie, bear with me. Think about the market as a room with a hundred people. If everybody has bought what’s left, if everybody has sold because of the development on the news, whatever that is, but everybody in the room knows. So what’s the problem? What’s the problem buying now? This is also a forward-looking setting. It’s more game theory, but it’s also forward looking.
I’m just trying to tell our audience how as professional investors in industry, how we typically evaluate scenarios or we actually look at numbers, but it has to be what’s next? What’s the next good? What’s the next bad? What’s the ratio?
Reggie: Okay, that’s cool and I know you do the whole asset allocation strategy, with all your macro factors and you look at the broad market. Main question is, have you changed your composite in any ways as a result of all these development over the past half a year? No? Okay, great. Important, right? Because that’s the whole long term… the whole idea of having that kind of long-term allocation.
Freddy: We completely ignore the markets. We are focused on leading economic indexes on growth, on inflation, on interest rates, things that ultimately drive returns crazy, up or down in the medium and long term. We focus on those big factors. That’s how the central bank work as well. They look at growth versus inflation. It’s a tug of war between the two. We call it inflation adjusted growth or real growth. That is our ultimate driver. We focus on it too.
The market event or rumours or policy changes… the effects don’t last forever. What lasts forever are the economic cycles. Summary, actually we don’t.
Reggie: With that idea in mind, how are you allocating your capital in the broad scheme of the whole world and all that jazz? For people that are listening, whether they are Stashaway users or not. I think people will be pretty interested to know how are you envisioning the broad world and how you’re allocating your capital along this whole world?
Freddy: It’s a great question. First of all, I don’t decide it. The machinery that we have built and stress tested and actual experience over the last four year… it systematically applies it. As u know the last four years, we have two market corrections in 2018, trade war, a pandemic last year, and the China route right now.
Reggie: It’s been a crazy few years. So yes, I feel you.
Freddy: I want to also FYI, our return ranges per year from 3.8% in Sing (dollar) terms for the lowest risk to around 16.8% per annum over the last four years. But it’s not by being faster and to react to something, it’s by being more systematic and consistent. So what is this systematic approach? It’s your question to me now.
First step, we look at slices of the historical data that correspond to the upcoming economic cycle. We dissect leading economic indicators like I said, to try to gauge where the economy is and then we slice the history for the past that’s most relevant to it. Otherwise, you have this long term data thing that has a lot of noises and garbages. So you need to find the most relevant slices of data as a starting point.
Then as a second point, we look at valuations of each asset class that we tracked. There’s a lot, hundreds… couple hundreds and we choose only some for you because the algorithm would choose from a big universe. That universe is a lot of asset classes and each asset class is valued against growth inflation and many other macro economic factors. In particular, we try to see where are the most overvalued places. Be careful, it’s a signal for FOMO (Fear of Missing Out), overcrowded investing situation. You want to be mindful. The risks are higher that you need to raise it. You need to lower your expected return.
Vice versa, on the other side, things that nobody likes today, underappreciated, we as long-term investors, we want to start building it up. After all DCA (Dollar Cost Averaging) investors, we will take time to build it up. I give you a good example on this one. It’s gold. We’ve been buying it since December 2017 when it was 1242 when we first bought it in a real meaningful way. Then during the pandemic, to provide protection against inflation and dilution of paper money because so much money is printed, we also fine tuned our gold allocations, very long-term view. We did it since 1240. We didn’t care whether it’s 2000 and came back to 1800, because it’s about portfolio insurance, but the valuation was very depressed. The second thing I told you, the valuation gap was so low versus economic fundamentals that we added on the assets. It’s been four years. That’s how it works.
Third one is a situation called fail-safe, managing uncertainty. When there’s too much uncertainty and the economic numbers, leading numbers, analytics, momentum, anything… doesn’t tell you where the economy is going. You simply do not know for now. We go into all weather strategies, splitting money across all possible economic scenarios equally to preserve a good risk adjusted performance rather than take a view. So that is the all weather strategy that we were on last year. That’s the third pillar for our system. It’s a very systematic process, a lot of things going on there. No single human being can say “I feel good here, I feel bad here. This is the allocation” and not just one portfolio, but for many people’s portfolios is impossible to do.
Reggie: Fair. So are you still holding onto the all weather strategy at this point of time?
Freddy: We have gotten out of that to inflationary growth regime in the US. Inflation momentum has really picked up. It’s 5.4% for the US right now. It was barely even 2% a couple of months ago and the momentum there is strong. We identified that the Covid situation has created a lot of disruptions to supply chain. Hence you can see base metals, commodities like food prices as well all going up because of this and it would take quite a few years for industry to adjust unless the vaccination drive is able to reopen borders.
We don’t know how long that’s going to take. Even though it’s not a permanent, forever thing, but a couple of years is enough to raise eyebrows and we want to protect the purchasing power for our users’ portfolios. So we reoptimized this portfolio on 21st and 22nd July last month to better prepare our users for this very peculiar environment.
Reggie: I know by right today, we’re going to talk about China. But since we are at this inflationary topic, I think this is also an important thing that we want to discuss. So I want to find out a little bit more about the whole inflationary growth regime. How is this different from the disaster case of a runaway inflation? How are you looking at it? Help us understand this because a lot of big high-level terms… I definitely want to get into your head on this.
Freddy: Inflationary growth is very interesting because you still got a good amount of growth and rebound the real economy to run on, but the problem is some pockets of the economy and some countries are running hotter. US is importing a lot of inflation whereas emerging market actually no. They are the one exporting the inflation. They’re gaining from it. So there are winners and losers. It create a lot of opportunities for a globally, very diversified portfolio to seize on. That’s what we’re trying to do.
US may confront the problem, but a global ex-US economy is actually less so. China inflation is very low. Even emerging markets are pretty tame, they are the ones exporting it. So it means Australian equities could be interesting. Some emerging market bonds could be interesting. Some global ex-US inflation linked bonds are also very interesting… natural resources, REITs as well.
So there’s a lot of opportunities as the economy starts to rebound. I also want to say the last time we have a very sustained long period of inflationary growth was at least 34 years ago in the 80s. Most of our managers have not seen it. If they’re senior, they are probably retired and so, the only thing to guide us is data. The fund manager track record may be less relevant than before because they never lived through it.
However, we believe that if a well-founded economic principles driven allocation machinery should, from the data that we see, create some sort of a buffer. But human experience could be very biased towards what you know.
Reggie: Can you help me understand a little bit more what do you mean by US is importing inflation? Does it mean that generally, the consumer price index in the US is going to go through inflationary cycle? It’s going to be a lot higher, it’s going to grow a lot higher. So then, based on what you’re saying, if that’s the case, are we trying to avoid putting too much money in the US or what is the game play?
Freddy: No, not necessarily, but you’re right in that you’re importing because food prices went up, base metals went up, because sometimes weather, sometimes Covid’s disruption to supply chain. You may say it’s just a few years, it’s not permanent. Nothing to be alarmed, but it’s real in the meantime for a few years.
The implication is that it’s not bad for equities. It’s just that you cannot prepare for it. Your real purchasing power from your equity return goes down. If you buy bonds and at a very low yield, then you also get the fixed income return… gets eroded even further.
So what it means is you are forcing investors to be more and more concentrated in the US stocks. That’s one of the problems and they need to start looking globally. They need to look away because US is the first one to rise. Emerging market has not really rotate yet, but could be the next one. So people need to study the supply globally more.
But what I’m seeing right now is a lot of build up in exposure because the market that goes up the most attracted the largest number of money. China’s recent route also got a lot of money back to US, buying those things on the high, right? At some point, this set up for a correction then it could be quite a bust.
For us, we look forward, like I said, what’s next, and you need to start thinking beyond just the US. So you’re right, the inflationary growth thing means whatever return you get from US stocks, for example, is going to get diluted more by inflation whereas globally, the return from other places are unlikely to be diluted because they don’t have this inflation story yet. Quite far from US. So opportunity will be elsewhere.
Reggie: Oh, okay. That’s a golden nugget opportunity… could be elsewhere. So back into China’s market and the discussion on China. I think a lot of people are exploring… definitely investing in China. So far the discussion here within our community or even in the local environment is not so negative towards China.
People are concerned, people are fearful for sure, but people are generally opportunistic and positive about China essentially. So when I looked through your fund selection, I know you have a whole algorithm that you’ve built to decide, and you have briefly shared all those stuff.
But within the funds, you predominantly have two main funds that has exposure to China. One is a Chinese tech, China emerging tech and the other one is Asia ex-Japan, MSCI All Country. Can you walk us through this two funds? I know the algorithms do most of the work, but you as a person, you’ll also be like “why these two?” For us that don’t have access to algorithms, I’m curious. Why these two funds?
Freddy: We first started with AAXJ, which is the Asia ex-Japan piece you mentioned, and by now it has about around 38% of allocation in China and around maybe 13% in South Korea.
Reggie: It increased, right? China’s exposure increased overtime.
Freddy: Increased and came back down because of recent… used to be 41%. Now it’s back to 38%. So it does actually change because of performance. But up until end of last year, it went as high as 41%. I think right now is about 38%. Don’t hold me to it. It’s just off the cuff.
Reggie: It’s okay.
Freddy: Yeah, but roughly there. It’s a broad base exposure to China. They buy everything under the sun approach, whereas the KWEB KraneShares, China’s innovation fund is more focused on e-commerce, internet software and the likes.
Now the algorithm chooses from the universe that we set up for them. All the time, the investment committee at Stashaway would always be on the lookout for other funds. We even have backup funds in case this fund has some issues we want to replace it. We also have regulatory requirements. Some of the funds fail below those requirements. We need to replace it.
So actually the universe is huge in the backend. If KraneShares for example, if you worry about the listing in KraneShares has 40 shares out of 53 ADRs, but they have the ability to buy on shore. There’s nothing to stop them, but if they are not doing it, we will be doing it for you by changing the funds. So there’s nothing to stop.
KWEB, for example, from redefining the index and directly invest in Hong Kong listed names or Shenzhen listed names, they’re buying ADRs in a legal setting, but there’s nothing to stop them from changing. A lot of names have secondary listing. It’s easy to replace. Some names may not have, so you simply have to just change the composition to something else.
That’s an easy thing to do. If they’re not doing that, they wouldn’t survive either. They have to do it because if they don’t do it, I will be doing it. So it’s a constant evaluation, the fund’s cash flow, the fund’s use of derivatives, the fund’s deviation from benchmark and even the tracking area in good market and bad market. We tried to really dissect a lot of this and over time we may change the list from time to time and then the algorithm would take the new list and work its magic, but we still define that universe.
So at the moment, we always want to look out for more exposure to different parts of China, but sometimes you say “why not have a semi-conductor one, Chinese only?” There’s no liquidity. Or “how about electric vehicle?” Then it’s very concentrated. It’s not a lot of liquidity. However, funds start redefining indices, names start coming in, we will monitor those things. Then we will include some funds as more diversify… so it’s like some people may say “hey, even though Freddy, you mentioned about hardware, 5G networks, you are still a lot more into either the traditional or all the way to the softwares?” that’s because of a liquidity constraint. We want to make sure when users need money, they want to withdraw, they get to be able to sell a portion very easily without paying too much. So we have that buffer.
Some parts of China will take time to be more accessible, that’s what we mean. But however, they are changing very fast and we are on the lookout for more funds in the mix. So you’d be surprised, we may even further fine tune the China exposure even deeper. Not because we are changing our view, it’s up to the algorithm, but we are trying to broaden it, deepen your riches as and when the liquidity in the market allows.
Reggie: Can you give me a little bit of idea like what is considered a highly liquid fund and what is considered an illiquid fund in your view?
Freddy: We look at the relative ranking and liquidy ranking relative to peers. Bloomberg published a score, it’s called an LQA (Liquidity Assessment) score. Bloomberg’s LQA score is effectively saying for what this fund does in the same category of all the funds in the world, what percentile ranking you are. Just so you know, by the way, on average Stashaway’s global flagship portfolio, ETFs (Exchange Traded Funds) in that component has an average score of 98.5 to 99 percentile in terms of liquidity. I mean, you can’t get better than that, and our 50% Sharia compliant portfolio in Malaysia, 50% global, 50% Sharia, also has around 97… it ranged from 96 to 97. So it’s super liquid.
We are trying to keep that in mind, when we construct a portfolio, you can’t just look at daily volumes. Because ETF changing hands doesn’t reflect the full volume. The underlying names that the ETFs are tracking has its own volume and it can trade off… exchange off market. You can’t see them on screen. So we look at a lot of these metrics and we want to make sure we get the best liquidity and the best diversification. That’s really key.
Reggie: Okay. That’s good. I think you definitely sound positive about China long-term into the future. Walk me through a little bit of… are you intentionally trying to increase your exposure to China in terms of your allocation? Are you trying to have a higher percentage in China specifically, because the broad MSCI World Index is hovering about 7% in exposure to China?
Freddy: I’ll give you two reasons. Sorry I jumped ahead, two reasons for you. One is the inflationary growth is actually good for asset class like China, because they tend to… if you look at their empirical data, their sensitivity to this, they gain from it, especially tech names. They even have a higher sensitivity to inflation trends. Two, valuation. Because of the fact of the near-term headwinds, it’s finally giving you an opportunity to buy a great potential in the long-term on the cheap today.
As DCA investors, this is fantastic. If you are a billionaire and you invest all your whole billion today right away, lump sum, maybe not because it’s going to be volatile. You may be annoyed in the near term, but for most of our savers, we have a job. We have monthly income with less spending. We save, we invest those savings beyond our rainy day fund. When we average in every time, this is a golden opportunity for you to build your portfolio for very great long term potential.
You can’t always buy the high, like I say, and you also don’t have your whole building right now. You’re building it up in… don’t know when you retire there, assuming you get there. It’s like… why are you caring about short term return? Because unless it’s 100% of the net worth or your total lifetime earnings being invested, then of course you are more sensitive and you may think like a trader.
But when you are building your savings nest every single month for the next 10, 20, 30, 40 years, what’s the problem? This is great. Alibaba, Tencent is not going to go away. The synergy between WePay, WeChat and all kinds of other things that are cross selling is massive. The marketplace from Alibaba is insane. Where else do you get such a company that’s going to grow with China? They just need to be put in the right place right now for the social good and then China will… they will be part of [indiscernible] Chinese expansion plan.
Right now, they need to be put in the right places. That’s what we’re seeing, hence the opportunity. But you don’t like… buy now, you’ll never get in. You’ll always be buying the high. Are you investing or are you trading? So that’s the ultimate end question for ourselves.
Reggie: Fair. I want to ask also about hardware… Chinese hardware tech. Like you said, maybe it’s not so liquid, but you’re probably observing some funds. I know when I say this, you always say “why you never open Stashaway account”? Not everybody is a Stashaway user.
Freddy: No, I have never said that. Don’t feel obliged, but if you do, I’ll give you a VIP discount code.
Reggie: Okay, thank you.
Freddy: Don’t feel bad about it.
Reggie: Yes. I think the idea here is I want to get VIP access to your brains of… what are some of the funds that you are looking at that will give us a bit more exposure, although they may be not so liquid now, but you are observing them in the hardware, Chinese hardware space?
Freddy: BlackRock, the iShares have some Hong Kong listing. The dollar denominator one is 9067HK. That’s the ticker. I think there’s a Hong Kong dollar denomination as well. Maybe it’s 3067, I’m not sure exactly, but it’s hard to remember the numbers. But the liquidity ranking is around 89%, it’s not 99, 98 or even 95.
We are monitoring. StashAway has not invested in it yet, but I’m saying like from a third party perspective. The CSOP local asset management firm has quite a few ETFs to track the Hang Seng tech indices. There’s also iShares China ETF that’s broader based. You have a combination of brick and mortar and internet names. So if you prefer that approach, that works well too. However, liquidity profile is nowhere near where I want it to be yet.
Reggie: Okay. So Hang Seng stuff.. iShares. I managed to dig something out for all our viewers. I think there’s one question that comes up in the community quite a lot. Why should I pay a premium for SGD denominated stuff? Why can’t I just like… management fee’s a bit higher if I want to have that SGD denominated? Why don’t I just buy US denominated or just buy Hong Kong denominated? They tend to be a bit cheaper wherever they come from. Essentially, there’s some sort of hedging.
Freddy: I wonder that too a lot, by the way. Stashaway grows global. For example, our 50 Sharia 50 global portfolio in Malaysia is actually trading in London and our global flagship is US exchanges. The Singapore exchanges, I think it’s justified in a case of funds that actually hedged all cash flow and return into US into Sing dollars. That costs money to maintain. Hence, the management fee could be a bit higher.
However, only a professional can work out what’s the right, fair amount of spread. So I know what I expect and if they go beyond on a number, then I know they are charging too much. But however, in most cases, Sing denomination doesn’t mean you’re hedged. It’s just that they offer a Sing dollar class of the same thing like gold, traded USD… [indiscernible] also has a gold equivalent in Sing dollar denomination. There’s no difference really, because no hedging is going on.
So I wonder why if there’s higher fees there, why people would do it? So that, I always… puzzled myself, maybe it’s my lack of financial knowledge, but…
Reggie: Okay, fair. Good point. Essentially, it’s a little… it’s a lot more complicated why people are doing it. But there’s also a little bit of discussion in the retail space that says if you’re in SG, you don’t need to be too concerned about RMB’s (Renminbi) fluctuation or RMB’s Forex because the SG government, essentially MAS (Monetary Association of Singapore) is tracking it very tightly and they are doing a lot of things to… with a basket of currencies, to ensure that the Sing dollar is collaborating and working along the Renminbi.
Freddy: It’s a fair point. It’s a very good point. The Chinese side is also on a managed band, very tight. The Singapore side is also on the managed band, so you’ve got double management. Whereas when you’re doing against USD, Sing against US or Yuan against US, it’s one side doing it. Sometimes they let it drift because they couldn’t hold it anymore. But when both sides (are) doing it, your chances of a stable currency for longer is very high. Actually, it’s a very valid point on this. It’s a fair point.
Reggie: So in other words, maybe you don’t need to pay a premium for SG hedging or SG denominated…?
Freddy: No, but my point is still, you need to go to the FX forward market to work out what is the… we call the term structure effects for… meaning if you hedge your cash for one year and down the line, why is the market naturally charging you? Because interest rate differential will give you… would cost you 0.5% to stop cash flow from dollar back to Sing, let’s say, for example. You know, if you fully hedge your return next one year, whatever you get in the US must be less half a percent. right? That’s the meaning of the pure market cost.
However, it’s not as transparent and to say the fund’s charging… the fund’s expense ratio when it’s not hedged versus hedged, the difference, you got to compare against FX forward market. I don’t know how many people have this info. I have, but I don’t know how many people out there actually have such clarity to evaluate whether it’s fair.
Reggie: Okay, fair. Let me try to speak that in layman’s terms. Essentially, the normal fund that is denominated in the US is not brought back to SGD currency as a certain expense ratio. If it creates another fund that is SG denominated, it will usually add a certain expense on top of the base expense ratio that it charges. Essentially, it’s charging us a little bit more to do that work of turning back to the base currency that we operate in here.
So with this premium, you want to make sure that it’s not a lot higher than the kind of fluctuation in the exchange rates between the base currency of USD to SGD. If the fluctuation here is about 0.5%, then it shouldn’t be more than the expense ratio. Is that what I’m hearing?
Freddy: Not fluctuation, but more like today the market tells you there’s a price. If you want to hedge… ensure your cash flow, the market participant, the pricing is you want to hedge one year forward in the future, that cashflow you want to bring it back to Sing. The cost is half a percent less hypothetically. That’s the market price for that and you lock it in.
You can lock it in today, but then if the fund manager incur more than half a percent, meaning the expense ratio for unhedged and hedged, the spread is more than 0.5 in this case, that means it’s a bit higher than what the market is charging. So then, it may be not very good for investors.
Reggie: And it’s actually okay to let it float also if you have a more complicated portfolio, what have you. We’ve talked about this the other time, sometimes you can use this to your advantage. It’s not always about hedging everything, everything has to be in control. So the basic idea is 50% base currency, 50% foreign currency, then you’re kinda already balanced out. I remember this lesson.
Freddy: Good memory.
Reggie: Of course important, we are in the space. I think we’ve covered a lot from China’s relationship with the US going forward and China’s internal regulation all the way down to different funds that you’re looking at, how to play the game or how to allocate your resources or allocate your portfolio to be exact. Is there any last things you want to add for us, specific to this whole China’s future, China investments and how do you look at this thing?
Freddy: I think… maybe more like a reminder as something that I said earlier, which is you got to think forward. News (are) noisy and so on. We’re bombarded by traditional and social media now. The more we need to stay on top of things in there. More news or more data doesn’t… more noise, doesn’t mean more insights…
Reggie: More tou tia (headache).
Freddy: More tou tia, more aspirin you need to take. So you need to ask yourself, the whole world knows this or not? What’s the next bad thing? What’s the next good thing? What’s the ratio between the two? Then you know whether it’s a good investment or not in the long term. I just want to re-emphasize that. Also, on closing, beyond that is ultimately, the majority of the success is actually not about the market. It’s really the financial plan.
I think Reggie, you can memorize this now. I’m going to give it to you. Before you invest a single dime, have your rainy day fund. Your personal circumstances will dictate what is the right amount. Once you have a rainy day fund, then you can start investing. You can average in, build a portfolio. Then the next step is what’s the right risk level for you? Meditate on it. Is a 20% extreme scenario drop something you can handle? If you can’t, bring down the risk.
It’s not about “I like China” or “I like US tech” or… none about that. It’s ultimately about all the speed bumps, whether you are able to handle those speed bumps. Budget that in, plan it in and then just stick to your plan ultimately. That was it. There’s no market timing, there’s no views or there’s no professional opinions. You don’t need that. You already have a diversified portfolio, you run along with it.
Reggie: For all of you that are listening specifically for the risk factors, for a long time I also don’t know what they’re trying to tell me by the way. Just reinforcing what Freddy is saying, essentially if there’s a 20% risk factor that means in the extreme case, it is expected to drop 20%. Or in extreme cases, it’s expected to drop 38% if the risk factor is 38. So if you buay tahan (cannot tolerate) the 38% drop, then you can take on a lower risk profile. Essentially, that’s what he’s trying to say. Because at first, I was like “huh? What is this risk profile? How to look at it?”
So thanks for joining us today. I think we’ve talked about a lot of high level discussions all the way down to the game play strategy. Thanks for expounding a lot of your thoughts for us. For everyone that is tuning in, if you have any questions you want to continue to have, come to the Telegram group, head over to thefinancialcoconut.com to sign up for our weekly newsletter and sign up for StashAway. I will try to get promo code, let’s discuss again. We gotta catch up for coffee. Take care guys, see ya.
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