Why Australian and Chinese stocks are high on this fund manager's watchlist

There’s no silver bullet solution that could have helped avoid, or resolve more quickly, any of the most recent market downturns, says Raf Choudhury, investment director – multi-asset solutions at global asset manager abrdn.

But the importance of discerning the different sources of the problems is a key lesson he’s drawn from living and working through the market calamities of 2008, the COVID downturn of 2020, and the latest inflationary-driven selloff.

“From a multi-asset perspective, having broadly diversified portfolios helps, but understanding the nature of the events and being able to adjust the portfolios accordingly is a key takeaway,” Choudhury says, reflecting on the 20 years he’s spent in the industry so far.

“There's no single broad-brush approach that you can apply to all of them. They all affect markets in different ways.”

In response to the current macroeconomic environment of higher inflation and rising interest rates, abrdn’s portfolio positioning has shifted to a more defensive footing. The original plan from the start of 2022 was to rotate into more quality-based equities, those with more stable earnings outlooks.

“But especially since May, we’ve been positioning more defensively in our portfolios in reducing our overall equity allocations,” Choudhury says.

Pointing to the abrdn Multi-Asset Real Return Fund as an example, its equity allocation is currently below 20% - from as much as 35% or 40% in the pre-COVID days.

“And within that 20% allocation, we're targeting much more defensive-styled exposures. But because of the indiscriminate sell-off that we're seeing across markets, we're also looking for areas of opportunity.”

Returns amid the latest selloff: abrdn Multi-Asset Real Return fund versus global and Australian equities

Where are the opportunities?

Choudhury says the team maintains “meaningful exposure” to Australian equities, which have been more resilient up to this point.

“There's a whole host of reasons for that. We're focused towards more quality-orientated exposures there, but from dividend yield to franking credits – you name it – there are lots of reasons to remain invested in Australian equities,” he says.
“We've reduced our international exposures, and we're starting to target some more Asian-specific exposures,” he says, referring specifically to China as it starts to reopen amid signs of the government relaxing its zero-COVID stance.

“We're a little bit more constructive on the China reopening story. We're conscious of the potential headwinds with the zero-COVID policy still being in place. But we do think that a lot of the downside's already been priced into the Chinese equity market, and so there's more upside potential.”

Weighing the inflationary and recession risks, alongside China as mentioned earlier, the abrdn team is also targeting equity exposures in other Asian markets, including Japan, Singapore and Indonesia.

In terms of the broader market, Choudhury suggests the teams view here is something of a contrarian perspective. This is also driven by the divergent monetary policy coming from China and some other nations in the region, which have maintained easy monetary policy and haven’t been raising interest rates as in developed markets.

“The market's probably still honed in on the downside risks there and the potential for the Chinese government to put them into further lockdowns, to impact manufacturing production further,” Choudhury says.

“But we think that they're on a pathway to reopening. It might stall, but they're heading in the right direction. So, we're positive there.”

Which equity sectors does he favour?

Abrdn is currently targeting more Quality in its Australian equity exposures, companies with more resilient earnings outlooks.

“But with earning seasons coming up, in July in the US followed by Australia in August, we think the market probably hasn't fully revised earnings estimates yet. We expect to see further downgrades across both markets, and so we're targeting a more quality-orientated style,” Choudhury says.

In terms of the local market, this means a focus on companies in the telecommunications and healthcare sectors.

…And which are less appealing?

Banks, for one.

“Yes, rising interest rates is a potential tailwind, but I think the rate and speed of interest rate increases will create more headwinds that will outweigh those tailwinds for the banks,” Choudhury says.

“You've seen a lot on the margin pressures that potentially come along with increased defaults as well, so we're just a little bit more cautious have started to cut our exposures to the domestic banks, at least.”

Fixed income and floating yield bonds

Speaking about his team’s exposure to non-equities asset classes, he says it has been reducing overall exposure to fixed income and corporate credit. High-yield bonds, which “in more normal times” would comprise between 8% and 10% of the portfolio are now at zero.

“But we do think Australian yields are currently pricing in interest rate expectations and where we expect the interest rate to land by the end of the year,” Choudhury says.

“There's potential that they could move a little bit higher, which might mean we see a bit more of a sell-off. But that's where we're seeking value.”

More broadly, they prefer floating rate bonds over those with fixed terms and are currently watching for signals on whether to start adding back some longer duration bonds.

Choudhury and his team are also maintaining their exposure to Alternatives, which have proven to be more resilient.

“We're targeting things like infrastructure and other alternative exposures in listed form, which have proven a lot more resilient than some of the other markets during this latest episode,” Choudhury says.

What’s the biggest threat on the horizon?

In a word, recession. The team of economists inside abrdn’s research institute spend a lot of time on scenario analysis, creating up to 20 potential scenarios and whittling these down to around 10 that the firm then shares with clients. These are a combination of higher risk but lower probability events; lower risk but higher probability; and various in-between scenarios.

“With the probability of recession increasing, that has the highest weighting across our different scenarios currently,” says Choudhury.

“So, we are less favourable on the US at the moment and also Europe, given more structural challenges that Europe faces in an inflationary environment.”

Broaden your potential 

abrdn's scale and breadth of investment expertise allow them to combine a range of specialist and mainstream asset classes to create smoother, long-term investment performance. Find out more by visiting their website.