Page 23 – Top1000funds.com

Capital markets continue to be a key battlefield of power between Beijing and Washington, and whether the yuan has a serious chance of taking over the dollar as the international currency is the next big question for the world economic order.

The struggle is especially evident in developing countries. While the influence of US capital has waned due to the shuttering of foreign aid organisation United States Agency for International Development, China is working hard to increase its presence through programs like the Belt and Road Initiative (BRI).

At the Top1000funds.com Fiduciary Investors Symposium, Asian law expert and Associate Professor at National University of Singapore, Weitseng Chen, said one unique thing about the yuan internationalisation scheme is China’s “capacity to maintain a dual system”.

“One system is the US dollar-based system that is the foundation of global capital markets,” he told the symposium in Singapore. “Nowadays, China is the largest beneficiary of globalisation. They try very hard to uphold the current system and blame the United States of breaking down this current system.”

“But on the other hand, China has established a quite effective alternative [currency] system.”

This system includes the BRI; the Asian Infrastructure Investment Bank, which is a previous extension of BRI but later broadened its investment scope to unrelated infrastructure projects in Asia; the Cross-border Interbank Payment System that offers clearing and settlement services for yuan; and the so-called ‘dim sum’ bonds issued in foreign countries but denominated in yuan.

Chen said users of the alternative yuan system are still limited, but its existence provides China with a plan B if it faces Russia-like sanction from the US.

“It’s already proved that [the system] is totally viable and possible,” he said.

“US sanctions against Russia failed simply because Russia has been able to switch to this alternative platform, it’s quite powerful.”

Chen said there is also a divergence in capital markets regulations between the two countries despite liberal scholars’ predictions over the past two decades that there would be convergence of globalised capital markets.

“Convergence indeed happened. If you check out regulations on securities, both in the US and in China, they look surprisingly identical on many regards,” he said. “But this convergence is kind of superficial.”

For example, investors have to opt in for complex deal structures like variable interest entity (VIE) if they want to invest in certain sectors in China with restriction of foreign ownership, such as technology. Under VIE, Chinese companies looking to list offshore will set up an overseas company, allowing foreign investors to purchase the stock.

The foreign investor is then deemed as a creditor, not an owner of the company, “with inferior rights”, Chen said, adding that the US market regulator is “tolerating” structures like this because it wants to attract listings in the US.

But from a legal perspective, these differences could cause global investors woes in periods of geopolitical tension. Overlapping jurisdictions in global markets create fertile ground for “legal warfare” between countries and investors need to stay vigilant.

“There is an undercurrent…but we just ignore it. When geopolitics doesn’t matter to transactions, it’s okay; but when politics matters now, it is not okay,” he said.

A world where the US dollar is no longer the reserve currency seems increasingly likely by the day, and institutional investors are wary that it could fundamentally change the way they construct portfolios.

At the Top1000funds.com Fiduciary Investors Symposium, Bridgewater Associates head of portfolio strategist group Atul Lele said one cause of the de-dollarisation trend – where the greenback’s status as the world’s main reserve currency is challenged – is the so-called “modern mercantilist” trade policies.

“[Modern mercantilism] is the idea that governments are really looking after their own sovereignty as their number one priority; seeing trade deficits as being something that is a transfer of wealth to other nations; and seeing the need for national champions to come back,” he told the symposium in Singapore, adding that one of its latest manifestations is the US tariffs.

US equities make up 70 per cent of the MSCI World Index and need strong capital inflows to maintain that status. But Lele said investors may be less willing to put their money into the market given restrictive new trade policies.

“One thing that’s for sure is that capital moves quicker than trade,” Lele said.

“The US trying to enforce a number of these policies is something that could be an accelerant towards funds not only not continuing to invest their marginal dollar into the US, which is a negative pressure on the US dollar, but also potentially pulling out.”

Another force behind de-dollarisation is political conflicts, Lele said.

“[After the] confiscation of US assets from Russia, you immediately saw not only Russia’s holdings shift away from US Treasuries to other assets, but the rest of the world starting to shift as well,” he said.

“That was accelerating a path that was already underway from countries such as China, who were moving away from the US dollar into assets such as gold.

“The question becomes, what do we actually trade in if we’re not going to be trading in US dollars?”

Planning ahead

CPP Investments’ head of portfolio design and construction, total funds management, Derek Walker, said that it’s not easy to scenario plan around de-dollarisation.

“The scenarios we run capture some elements of that [de-dollarisation possibility], but I think it’s a really challenging one to work that all the way through,” he said.

“We are trying to capture – in the scenarios that we’re running – different states of the world that are more disrupted than the current one, but maybe not to that extreme like a major de-dollarisation of the [world] economy.”

For example, CPP Investments would examine different allocations and asset class relations in a world with stable inflation and growth, as well as in a world with higher inflation and more volatile and lower growth.

But Bridgewater’s Lele said a lot of investors today are making a big bet on a continuation of the past 10+ years of a pro-corporate, pro-liquidity, pro-growth, disinflationary boom and period of global harmony. Understanding different regimes is critical, as investors seeking portfolio resilience need to think about the probabilities of a range of investment outcomes and be conscious of which scenario they are betting on.

“[Investors] are saying, probabilistically, we are keeping our allocation the way it is, a 70/30 global portfolio, [then] they’re making a bet that you’re going to see a repeat of what is amongst the top 5 per cent of performances going back over the last 100 years.”

“So building resilience includes: number one, thinking about what resiliency means to you; number two, recognising the full range of outcomes that you can get and where your vulnerabilities are; and number three, starting to pull the levers that you can pull to mitigate those vulnerabilities.

“These are the things that really start to impact the path of your returns over time.”

Also presenting on the panel was Man Keung Tang, managing director of macro strategy at Singapore’s Temasek.

The global environment in which small Asian economies have thrived over the past seven decades is being dismantled as the US retreats as an advocate of multilateralism, globalisation and internationalism, warned leading geopolitics academic and economist Danny Quah.

Quah, who is Li Ka Shing Professor in Economics and Dean at the Lee Kuan Yew School of Public Policy within the National University of Singapore, said he is of the view that “Asia remains the future [of global growth], but now it’s a more difficult story”.

And to understand Asia’s future, investors need to reflect on its past.

“Most of Asia approaches economic growth and development, and their engagement with the world, as if we are small, open economies. Even the very largest, most populous of us are small in the economic sense,” Quah told the Top1000funds.com Fiduciary Investors Symposium in Singapore.

“When your economy remains small, you are hemmed in.”

However, this status has not been a problem for Asian countries in the past 70 years because the world was filled with promises of a level playing field, global co-development and free trade – the region “latched on to” these ideas, Quah said.

“The grand themes at that time were economic efficiency, comparative advantage – Milton Friedman-esque ideas – and convergence: that as economies grew, politically they would converge to the norms of liberal democracy on the transatlantic axis,” he said.

“We went about our way…improving the supply side, [it] meant that we were reassured the demand side for us was always going to be there. That’s no longer so obviously the case.”

Quah said for Asia’s growth story to continue, it is critical that “a variant of that system continue”, or the region will face excess capacity and mounting inventories.

“Every small economy always produces too much of what its people can [produce], and too little of what its people need,” he said. “And given the trade is an existential need, it is an urgency for Asia’s development.”

“So if Asia is going to be the future, and we’ve got a world that’s decided to pull back on multilateralism, we really do need to rethink…our operating and conceptual models.”

Retaining a sense of order

The reality for most ASEAN countries and some others in greater Asia can be summed up by paraphrasing Greek historian and general Thucydides: “Great powers do what they will, the rest of us suffer what we must,” Quah said.

“Either China, America or some other great power needs to build the world, if they have decided to step back from that, then we’re caught. Because we have no agency,” he said.

But there are things small Asian countries can leverage to benefit as the world shifts to a new order. For one, it can strengthen region-based multilateral systems.

“Multilateralism, as I’ve described, is a level playing field for all of us to engage with everybody else, with clear rules of engagement – a rules-based order,” Quah said.

“[But] America, the wonderful sponsor of a rules-based order has, for many interpretations, decided to go with a might-makes-right kind of a perspective,” he said, with President Donald Trump’s threats to annex Canada and Greenland.

“If we can’t any longer have a rules-based order for everyone in the world, let’s build a rules-based order for ourselves,” Quah said. “ASEAN in Southeast Asia is part of that construction.”

Quah added that he does not yet see great coherence in a China-led order in Asia, although trades with the East Asian nation have benefited the rest of the region.

“The last century of China’s history has left many of us a fear that China remains a dangerous nation. China went through the great purges of the Cultural Revolution [and] the Great Leap Forward,” he said.

“The rest of us have never had to experience anything like that. We don’t understand China. China doesn’t understand us. I think it would be very difficult for us to buy into a China-led order.”

The radical shift in world geopolitics has prompted the Monetary Authority of Singapore to rethink its strategic asset allocation in favour of a more granular approach.

Bernard Wee, group head of markets and investment, Monetary Authority of Singapore, drew a parallel between current events and the 1940s and 1970s, which were also characterised by political uncertainty and conflict.

“Those are exactly the same forces, the same things that are happening right now,” he said on a panel session during the Fiduciary Investors Symposium in Singapore. “If we think that our strategic asset allocations are something that we can just set and forget, that’s something that I would not presume to be true for the coming few years.”

The Trump administration’s focus on trade restrictions and national security has quickly brought geopolitical risk to the fore. Wee said taking a more granular approach would be important for investors, using the differences between major emerging market economies China – with its rapidly ageing population – and India as an example.

“Some of these differentiated characteristics make for a standalone allocation to China versus an EM ex-China, and you can apply the same lens to DM, right, because the US has a very different demographic profile from Europe and Japan.”

Wai Seng Wong, head, strategy, Khazanah Nasional Berhad said the distinction between emerging markets and developed markets was no longer as useful in this “multi-polar world”. He also said the Malaysian sovereign wealth fund needed to be more granular about its exposure.

The fund had a relatively low 40 per cent portfolio exposure to the US and had planned to lift its developed markets exposure – which was largely North American-based – to about 80 per cent.

“This whole discussion, as well, makes us take a pause really. Is that 80 per cent goal that we had earlier the right way to think about it? Probably not anymore.”

Nonetheless, the fund was ready to opportunistically invest more in the US.

“We just have to be ready for US opportunities if it arises – or when it arises – in terms of valuation, in terms of a downturn and whatnot.”

Also presenting on the panel was Christopher Chan, chief investment officer, public markets, at the Hong Kong Monetary Authority.

Data analysis driven by machine learning is generating as much as 50 per cent of alpha in certain equities strategies managed by Pictet Asset Management, according to its head of quantitative investment David Wright.

At the Top1000funds.com Fiduciary Investors Symposium, Wright said AI will not only provide drastic efficiency gain for traditional stock pickers but also will be a defining part of “quant 2.0”.

“The arrival of machine learning in the quant space is not a revolution. It’s a part of a much longer evolution in the requirement for more data, more technology, and more computing speed,” he told the symposium in Singapore.

“It was the early 2010s when machine learning was first looked at by quants, predominantly as a way of analysing new types of data or text documents with natural language processing.

“This was done in response to the crisis that happened in the quant industry at the underperformance of a lot of traditional risk premia.

“Today, quants are using a variety of different machine learning strategies to support our investment processes.”

Wright said Pictet has been running AI-driven long/short and long-only strategies for several years, which currently manage $2 billion. They have a machine learning component to make short-term stock forecasts. Its process consists of data preparation – such as determining what data points to use and defining the target – then model training and prediction.

He explained that the so-called “conditioning” element of AI-driven quant, which analyses and acts upon the interaction of different non-linear data points, is what sets it apart.

“[It’s] almost rules-based, like don’t follow an analyst upgrade at this point because the stock is heavily shorted and it’s near to its reporting period,” he said.

“That conditioning piece is what you don’t get from a traditional quant model.

“That’s probably generating 50 per cent of the alpha that we’ve seen, that’s consistently between long-only and long/short, and we see it pretty consistently quarter-on-quarter as well.”

Machine learning is also helping to overcome another key quant-investing challenge in the trade-off between a model’s complexity and its accuracy. Wright highlighted that traditionally, overtly simple or complex quant models both run the risk of reduced accuracy, as they either have too little information to make an accurate prediction or become over-fitted for the ultimate investment process.

“With linear models, what we spend a lot of our time doing is trying to work out where the bottom of that U [shape] is,” he said.

“Now machine learning offers the potential that we don’t have to spend the time looking for that optimal point.”

Staying ahead of the game

However, Wright said in response to a question from the audience that it is very difficult to “build a moat” in AI-driven quant investing.

“I don’t think we have a data source that no one else has. I don’t think we start with an algorithm that no one else could use. I don’t think we have an implementation that no one else could use,” he said.

“In the same way quant has always been, if you’ve got to a point that there are people following you, you’ve got to make sure when they get to where you are, you’re not there anymore.

“You continue to add more data, continue to refine your algorithms, continue to refine your implementation.

“I think it’s trying to make every single part of the process as effective as possible, but don’t be naive and think [in] any one single part of it, no one else could do well.”

This also provides considerations for asset owners in their manager selection process if they are thinking of tapping into AI-driven quant strategies.

When this happens, Wright said they are in search of five key things: pure alpha stripped of any common factor effects; active returns that are independent of market regime; strategies customisable according to their needs such as risk level or ESG; strategies that are implementable in different ways; and data transparency.

Different manager models have different pathways: for example, what type of learning does it use? Is it supervised learning? What are they forecasting? Are they going to be economically driven or data driven?

Wright encouraged asset owners to understand exactly what they want from the strategies.

“A lot of the decisions that you make as humans start to send you off in different directions,” he said.

“It gives me a lot of comfort that even if you take the same starting point, you’re not going to get to the same place as a lot of your competitors.”

For more than 20 years, the investment environment has been markedly friendly, with markets boosted ever higher by accommodative monetary policy, unimpeded trade between countries and a relatively benign geopolitical backdrop.

But with trade wars – and real ones – now sweeping global markets, the asset owners that ply them for returns might have to rethink their strategies.

“If we look at the Australian superannuation funds, a lot of them have got a very risk-on approach – 70/30 [growth/defensive split], or more than that,” Yue Cao, principal for strategy and planning in the office of the chief investment officer at the $216 billion AustralianSuper, told the Top1000funds.com Fiduciary Investors Symposium in Singapore.

“If you take more risk, you’re more concentrated in the US, and you’re getting a pretty good deal. But now the risk mitigation, the downside protection, is probably more front and centre.”

But the timing and magnitude of portfolio changes matter, Cao said, and asset owners have to block out the short-term noise – like the constant stream of headlines generated by the Trump administration – and be open to new information in order to make decisions effectively.

“Given that it’s a lot of change, we don’t want to pretend we know everything; we have to build, relentlessly, this openness and agility in our decision making and take on different perspectives,” Cao said.

“How do you make sure that different voices, those unwelcome voices, get a place in the decision-making? Asking the right questions gets you a better result than defending the answer you think is right.

“But what’s exciting for me is that the next 10 years are going to be a much more exciting period than in the past. It’s more difficult, but we will see more diverse approaches to deal with those things.”

Investor anxiety

John Greaves, director of fiduciary management at the $42.2 billion defined benefit pension fund Railpen, echoed the sentiment. Railpen is still targeting high levels of return and wants to take on illiquidity risk, but has the growing sense that the “portfolio is perhaps not well set up for the coming decades”.

“Probably like a lot of portfolios, if we’re being realistic,” Greaves said. “But the challenge is, what do you do about that? We’ve been very reliant ex-post on the equity risk premium, and that’s mainly come from the US, and in previous decades it’s come from other parts of the world. So we have about 40 per cent of our assets in the US, but it’s about 70 per cent of our equity risk across private and public. And the rest of the portfolio tends to be more secure credit, real asset, government bond type assets. It’s consuming a lot of our risk and it’s a key driver for us.”

So Railpen could geographically diversify its portfolio, or bring new assets into it – which it’s been doing, with the addition of more credit, real assets and diversifying strategies. But that might not be enough, Greaves said.

“What if assets just generally across the board are not going to be delivering the returns, or at least the real returns, that you need?” he said.

“I’ve had a lot of conversations on what a more dynamic, nimble process might look like, in terms of trying to read the tea leaves of what’s priced in and what’s happening now that’s fraught with risk. So how do you systematise that and build it into a reliable process? But it might be a requirement of the world we’re in.”

That world is probably one where there are more macro shocks, Greaves thinks, driven by the changed policy responses of central banks, economic protectionism and geopolitics – and asset owners will have to spend more time thinking about non-financial risks. Aaron Bennett, CIO for the $11 billion University Pension Plan Ontario, agrees.

“I love thinking about geopolitics, though in the 25 years I’ve been in finance I’ve often viewed it as idiosyncratic – something I can avoid,” Bennett said. “And one of the things that has really hit home with me is that the geopolitical risk that we’re experiencing does have the potential to be systematic and not idiosyncratic, and that’s quite scary, and does cause you to think differently about your overall portfolio and your exposures.”

Portfolio trend

But the economic disruption started by the Trump administration could also have a hopeful element.

“There’s the idea of galvanisation, and what the opportunity is around that for my own country, Canada, and for others. And we’ve seen what used to be considered politically impossible in Germany look like it’s actually going to happen, and I think about other countries where that could actually happen.”

And there are other shifts to reckon with – like the switch more and more asset owners are making away from strategic asset allocation and towards the total portfolio approach (TPA), which has become increasingly popular and has found advocates and users in the likes of the Future Fund, NZ Super and GIC. According to June Kim, senior investment director at the $350 billion CalSTRS, it seems like “everybody’s doing TPA, or moving towards it or thinking about it”.

“And what is TPA?” Kim said. “Everybody has a different interpretation or way of implementing it.”

“I started to worry a little, because is this an area where the alpha is going to dissipate because everybody’s doing it? I don’t think so, because it’s a process and a philosophy rather than an investment strategy. We’re in the process of trying to implement a more centralised lens – we’re calling it total fund management.”

Following the appointment of new CIO Scott Chan in 2024, CalSTRS is currently assessing the risks and resiliency of its portfolio across public and private markets to see if there are “any big gaps”.

“The recommendations that come out of this in the next couple of months will lead into potential asset allocation shifts as we go into our every-four-year asset liability management study and the prep work for that,” Kim said.

“Anything would be at the margin given the size of our portfolio. But one of the areas we’re looking at is the defensive bucket. We have a 10 per cent allocation to risk mitigating strategies. Their whole purpose is to be a hedge to our growth exposure and that’s a large chunk of the portfolio, so part of this exercise is to see what’s the right sizing of that.”