On November 15, ASX held a panel session in Sydney to share insights on the current buy-side equity environment and forecast potential trends for 2023. Participants included Josh Heller, Head of Solutions at Challenger; Julia Lee, SPDR ETF Equity Strategist APAC at State Street Global Advisors; Robert Risk, Business Development Manager at Susquehanna International Group; and Mel Cooper, Head of Electronic/DMA Sales at Credit Suisse.
Hedging amidst headwinds
Invited by moderator Dawn Lay of ASX, the speakers emphasised the difficulty of generating strong returns. A conspicuous feature of the current economic slowdown is that asset performance is correlated and there is low stock dispersion.
As a result, hedging strategies are being deployed in view of the difficulty of beating the market. There is renewed interest in currency hedge products, gold and hedged ETFs. Market volatility has also led to growth in derivatives, including short-term options, propelled by the likes of India, South Korea and the United States.
Heller observed that investors who expand into derivatives need to protect their portfolio against downside risk. “Negative carry of say 50 basis points is Alpha (risk-adjusted return) that you need to make up elsewhere when the market rallies,” he said. However, you don’t just lose 50 basis points immediately, when you own a derivative, you still possess something that has value in your portfolio. Therefore you can’t think portfolio is here and your protection over there; they actually interact.”
Navigating liquidity challenges
Liquidity is a particular issue in equity markets. A function of how easily assets can be bought or sold, it has been affected by volatility caused by this year’s central bank interest rate increases.
Block trades, in which institutional investors and hedge funds privately negotiate large transactions, undercut liquidity as they circumvent the market. “Blocks are going up in size and value,” Cooper said. “Whereas a few years ago, you might get blocks worth $5-6 million, now they are $10 million or $15 million going through the market every day.” Dark pools also enable buy-side players to trade in secrecy from the public, avoiding price distortions.
All is not lost. The Australian market is likely to gain more liquidity from overseas investors, drawn by the appreciating Aussie dollar. Super funds, as large asset holders, are uniquely placed to join banks and other market makers in supporting liquidity while chasing good returns.
Closing auctions and regular rebalances on stock exchanges such as S&P and MSCI have also become significant liquidity generators. The latter are advertised transparently, enabling market participants to game predicted changes to equity indexes. Cooper noted that $40 billion was traded as part of the demutualisation of BHP earlier in the year. “These events give so much opportunity in the market to fund managers if they want to tap into that liquidity to make a change to their portfolio,” she said.
Looking ahead to 2023
At the institutional level, Risk suggested that Australian investors may show a greater interest in ETF funds that track global markets, including IVV, VGS and NDQ. Additionally, fixed-income ETFs are also beginning to look attractive, particularly as the yield on US Treasury bonds is close to 4%.
He added that interest in thematic equities could rebound in, for example, emerging technology areas such as hydrogen, artificial intelligence and robotics. Funds focused on climate and environmental, social and governance (ESG) are also worth watching. ASX is exploring the idea of an ESG index that would provide a benchmark of socially responsible companies.
Economic news remains key
With the spectre of a US recession and a spate of expected earnings downgrades, Lee emphasised the macroeconomic picture would continue to overshadow company fundamentals. “In the old days, you used to see rising rates and a strengthening economy. Now interest rates are increasing into a slowing economy and I don’t recall seeing that before,” she said.
One consequence is to position investments such as term deposits as a safe harbour. “In a world where cash is not zero, an absolute return fund paying cash plus 5% yield is pretty good, the idea that you need 15 or 20% returns every year is a fallacy we’ve been lulled into in this equity world,” Heller suggested.
Above all, speakers agreed there is a degree of market exhaustion as investors sweat on economic developments. Recalling the global financial crisis of 2008, in which ructions occurred over a period of several months, Heller added: “we’re just in the first couple of innings of how this is all going to play out”.