Equity markets might be tough hunting grounds for investors this year. Views are also split on whether the worst is yet to come or is behind us. When equities appear directionless, because of elevated uncertainty or a lack of conviction, opportunities can still be found, and Asia offers plenty of them.
Financial market sell-offs are frequently driven by macro news and sentiment. Stock prices often plummet in a crisis, with volatility and correlations spiking and being especially elevated for some time. Charging inflation and interest rates have exacerbated this problem recently by ushering in a regime of positive correlation between equities and government bonds.
It’s all about alpha
For months now, we’ve advocated the importance of being (and staying) diversified. In particular, we’ve been vocal about the need, when appropriate, to consider investing in alternative assets to target better risk-adjusted returns. With that simple goal in mind, one strategy might be worth considering: market (or beta) neutral equities.
Behind the fancy name, these strategies eliminate the need to get the market’s overall direction right (the beta) and instead focus on generating value by going “long” an asset and shorting another one with similar characteristics. This idiosyncratic performance is commonly referred to as alpha.
Dispersion, dispersion, dispersion
In order to generate attractive alpha, fund managers need two things, a rigorous process and talent. But these aren’t of much help if alpha opportunities are few and far between. This is why dispersion of returns between markets or securities and low intra-correlations are two prerequisites.
Unfortunately, the influence of central banks on markets in recent years has suppressed a lot of the alpha opportunities that once existed. Indeed, an increasing number of investors simply follow the market’s momentum in setting strategy, paying little attention to fundamentals.
This tide, that lifts all boats, makes alpha generation harder, especially in the western world. In fact, the S&P Indices versus Active (SPIVA) scorecard, which tracks the performance of actively managed funds against their respective category benchmarks, recently showed 79% of domestic equity funds underperformed the S&P in 2021.
Asia is an ideal hunting ground
However, alpha generation has been easier to come by in Asia. There are a few fundamental reasons for this.
First, Asian equity markets, unlike their US peers, include companies from very different countries that each face their own macro trends (some being emerging markets). Second, Asian companies not only operate in many currencies, but their shares are listed in different currencies too. This makes exchange rates a key driver of alpha. Finally, stock markets in the continent offer exposure to a very specific blend of sectors and industries that allows for additional dispersion.