China is the biggest risk factor facing investors, not the US or UK, according to SYZ Asset Management’s Fabrizio Quirighetti.
The manager of the £245m Oyster Absolute Return fund said he has not changed his view on the economy for more than a year, despite the pick-up in volatility witnessed in 2018.
Markets suffered a difficult October, which was among the worst months of falls for global equities since the global financial crisis of 2008, ending the month down 5.6 per cent.
Performance of index over YTD
Source: FE Analytics
Markets fell on the back of more hawkish rhetoric from Federal Reserve chair Jerome Powell, who implied that interest rates may need to move higher than expected.
“Clearly there are worries on the economy because of higher rates which will force some companies to deleverage in the US,” he said.
This, together with deleveraging in China, Brexit, an Italian government threatening the position of the EU and trade tensions between the US and the rest of the world, means that there are now more headwinds than there were previously.
The biggest risk, he said, comes from China, although this is linked somewhat to the US as the two largest economies target each other with trade tariffs.
Quirighetti said: “One year ago China decided to get some control on credit growth and to restrict peer-to-peer lending, shadow lending and all that kind of thing to avoid uncontrolled credit expansion.
“That is what has driven a slowdown in growth, which was already visible at the beginning of this year.”
This decline was somewhat expected, given the extraordinary growth levels achieved by the country for a long period of time, but the management of it remains a key issue for the government.
“The surprise for China has been the trade wars and that means that they have to now deal with two sides – internally on the grip with credit growth but also trying to counteract the negative side on the trade wars with the US,” the manager said.
The question, therefore, is whether China is able to cope with these two headwinds or not.
Quirighetti noted that unlike in 2008/09 when authorities increased leverage to sustain the high levels of growth at any cost, this time they are being much more monetarily aware.
“They have decided to do some tax cuts which will help consumption rather than helping easy investment expansion,” he said.
Part of this is because the government will struggle to lower interest rates as it will likely trigger a weakening of the renminbi against the dollar – something the government cannot afford if they wish to achieve their long-term goal of making the currency an alternative global reserve.
Additionally, lowering rates will cause dispersion between the markets, potentially tempting Chinese investors to look outside of the Chinese currency or economy to invest in US assets.
“They have not done that but have decided to reduce the reserve requirement ratio and also more have emphasis on developing the rural areas, which have lagged behind over the last 10 years,” he said.
The government “are manoeuvring with some agility in order to sustain the economy,” he added, meaning that any potential risks will likely come from a trade war with the US rather than a policy mistake.
As such, while the risks are growing, Quirighetti said “we still believe we are not close to a recession”.
“We believe that the situation is quite healthy in the sense that if you look at the economy, usually when you have a recession you have an acceleration most of the time in investment,” he said.
“There has been some exaggeration on the financial market but, as far as the economy is concerned, I have not seen big overspending in the US or in Europe.”
However, his strategy remains one that is more focused on capital preservation and cautiousness than shooting the lights out in a rising market.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
While Quirighetti has managed this strategy since 2003, the current fund was launched in 2014. Since then Oyster Absolute Return has made a total return of 4.06 per cent for investors, beating its benchmark, as the above chart shows.
It is slightly behind the IA Targeted Absolute Return sector average, although it should be noted that the diverse group of funds within the sector makes it difficult to draw comparisons.
Currently it has 20 per cent of its portfolio invested in equities – quite a large weighting compared to its history and not far from its 25 per cent limit for the asset class.
“In our more risky portfolios we have somewhat rearranged the allocation towards more equities in Europe or emerging markets and we are contemplating parts of the market that have lagged,” he said.
However, to protect the portfolio on the downside, a new position he has added to is gold, which he bought in October.
Typically, when interest rates in the US rise, this pushes the dollar higher and therefore reduces the opportunity-cost of owning the precious metal.
But so far this year the S&P GSCI Gold Spot index has held up better than expected, up 2.27 per cent in sterling terms.
Performance of index over YTD
Source: FE Analytics
Currently, central bank rhetoric has centered around moving real rates rather than any signs that inflation is beginning to come through in the system. However, with unemployment at historic lows and wage pressure building, it could be a matter of time before prices start to rise – something that has typically resulted in the gold price rising also.
“US real rates have now adjusted and they cannot move much higher,” he explained. “If we have another increase in rates it will be due only to an increase in inflation expectation and if now we start to have inflation coming into the scenario that will be something that will benefit gold.
“Perhaps you may even have real rates coming back,” he added, which should be a big benefit to gold, which does not have a yield and is therefore less attractive in a rising interest rate environment.
With Fed normalisation already priced in, all the good news about the US and dollar already quite high, he said this is also not out of the realms of possibility.
“I see an asymmetry where the downside on gold is quite limited and you have potential upside,” the manager said.