A DUBAI client that Guy Monson, chief investment officer of Sarasin & Partners, met recently is probably representative of a large number of Asian investors.
The client had an investment in a credit-linked structured note. He said he was not worried about it as it was capital guaranteed over five years.
'He lived in Dubai, where inflation was 11 per cent. I said - if inflation stays at 11 per cent, you get your money back in five years, but you would have lost 68 per cent. People have to get their minds around inflation and currency risks.'
Mr Monson is calling on Asian investors to move out of cash, bonds and structured products into real assets. The latter includes equities.
He says investors should buy Western blue chip stocks rather than Asian blue chips. And they should be prepared for continued appreciation of Asian currencies.
'For the first time in a generation, the modern Chinese investor has to deal with forex losses. They are holding US dollars and the renminbi is up. Idle balances left in US dollars have been expensive.'
He adds: 'There is a unique opportunity to buy cheap Western blue chip stocks. Equities are now more cheaply valued than bonds than any time in the last two generations, cheaper than 1974, than 1981 and 1987. It's a huge opportunity to switch out of cash where you get negative real rates, into the best blue chip companies in the world.'
Mr Monson, who joined Sarasin in 1984, claims to have pioneered a thematic approach to investing when he launched the EquiSar family of funds for the group in 1996.
'The old model of country and industry allocations doesn't really work for modern global companies. I was regarded as an eccentric in 1996,' he recalls.
The EquiSar family of funds has delivered an annual compounded rate of return of between 12 and 17 per cent over five years.
Sarasin manages some US$15 billion in assets using the thematic approach, including multi-asset funds.
Mr Monson sees three major macro themes dominating markets in the near term. These have implications for investment strategy.
The first is that Fed chairman Ben Bernanke will avoid recession at all costs.
But aggressive rate cuts have helped to fuel commodity prices, as real interest rates in the US were pushed to minus 2.44 per cent.
'I think there won't be a world recession, but there will be higher inflation,' Mr Monson says.
The second theme is the 'upside-down' world of currency pegs.
Most of the developing world have their currencies on a dollar peg or float. 'If Bernanke pushes US rates down, he affects local markets.
He sets rates for two thirds of Asia and the emerging world. The last thing Asia needed was to cut rates.
' As a result of the dollar linkages, roughly half of the world currently has negative real rates.
'This is extraordinary. It is very bad for inflation and asset price inflation.'
The third theme is what Mr Monson calls 'the dark side of globalisation', referring to commodity price shocks and inflation.
Subsidies in key emerging markets have propped up energy demand, but the subsidies are breaking down.
'I have been very negative this year on Asian equity markets. I worry that the combination of rising wages, rising commodity prices and currencies will damage corporate profitability. Growth will be there, but corporate profits will be lower.'
The weighting of Asia ex-Japan equities in the portfolios is at its lowest level in 10 years at just 2 per cent compared to 20 per cent in 2003.
'I cut the positions too early, but now I've been proven right,' Mr Monson adds.
He expects 'great investment opportunities' in 2009, saying Western equities will outperform over the next six to 12 months.
US stocks offer strong balance sheets and cash flows, he says. The ratio of companies' interest payments on debt relative to their cash flows is at its lowest level since the 1960s.
Based on long-term market data dating back to the 1950s, US equities delivered returns of about 15 per cent a year, when inflation was between zero and 6 per cent, and UK equity returns ranged between 14 and 16 per cent.
'In the current market, it's a brave call to say people should buy blue chips. But there is no balance sheet risk. Even if you exclude the banks, the earnings projections are quite good at 12 per cent and at a very cheap level,' says Mr Monson.
'I don't think Asian equities will crash, but there is more pain in the second half. Western equities are so cheap and the dollar is so weak. If you're a contrarian Singapore investor, you take your strong Sing dollar, buy American blue chips and to a lesser extent European and Japan.'
He expects to begin buying financial stocks in the next two to three weeks. There is a caveat to thematic investing in that it is vulnerable to market exuberance or momentum trades.
'When people fall out of love with theme stocks, it's normally a dramatic process.' Mr Monson tells investors to buy multiple theme funds rather than just a single theme to mitigate this risk.
'The second advice is to sell early. You're very vulnerable to momentum. When you see it in the front pages of newspapers, you should start selling.'
This article was first published in The Business Times on 25 June 2008.
