“Leverage has been increasing in the corporate sector over the last few years. With low interest rates, companies have borrowed much more,” Ramjee said at a recent media briefing in Hong Kong.
With rising interest rates, the firm is now cautious on companies that have become more leveraged versus their history. The companies that have accumulated more debt are mostly in the defensive sectors, such as consumer staples, telecommunications and utilities, Ramjee said.
“The safe sectors are the sectors that are not so safe now.”
On the flipside, sectors that have been perceived to be riskier, such as consumer discretionary, materials and information technology, are less leveraged.
“These cyclical sectors, which were historically perceived to be risky, are better sectors to hold in a rising interest rate environment than the defensive ones,” Ramjee said.
Banks and commodities
Against the current macro-economic backdrop, the firm finds opportunities in companies that benefit from rising interest rates and inflation, in particular, banks and companies in the commodity sector, according to Andy Wong, Hong Kong-based senior investment manager for multi-asset.
“With rising interest rates, banks’ profitability is potentially better because they could profit from loans more,” Wong said during the briefing.
Wong added that globally, the valuations for banks are very attractive, especially for Chinese banks. “For Chinese banks, you can see a big valuation discrepancy as they were not given the credit for the kind of return on equity (ROE) they are generating,” he added.
For commodities, Wong said that they do well in an environment of rising inflation. As inflation increases commodity prices, company revenues will likely move in tandem. He added that valuations have become the most attractive in 40 years and are increasingly giving investors dividend opportunities.
“Commodities can give you a hedge to inflation and at the same time, very good dividends.”
Another sector that Wong believes will provide opportunities for investors is technology, particularly hardware companies that support the underlying growth of robotics, automation and data centres.
“So it is not just the internet platforms but also the tech companies that support the underlying growth of these themes,” Wong said.
For example, Apple and Facebook have announced that they are increasing their investment in data centres. “To support that, you actually need a lot of memory [capacity], processors and servers,” he said.
Wong acknowledged that valuations may be high in the technology sector. However, current ROE is, on average, almost 20% compared to 10%-11% in 2000.
As interest rates and inflation rise, the firm expects that financial markets will be more volatile this year than the last several years, according to Ramjee. He highlighted the importance of making more tactical investment decisions this year.
“Moving between assets will provide much more value this year than it last year, when all assets went up steadily,” he said.
Other fund managers, such as Eastspring Investments, also highlighted the importance of tactical portfolio decisions in 2018.
“This year will be much more volatile, so there are two things you need to do: Always go back to valuations and be much more tactical this year even if you are a long-term investors,” said Virginie Maisonneuve, Eastspring’s Singapore-based chief investment officer.