This article first appeared in Capital, The Edge Malaysia Weekly on April 18, 2022 - April 24, 2022

LOCAL unit trust funds have increased their cash holdings amid growing risks as a result of interest rate hikes and the Russia-Ukraine war. According to JP Morgan’s April 1 note, the cash levels rose to a 12-month high in February, amounting to 11.2% of assets under management.

This compares with 10.2%, 9.3% and 9.1% in January, December and November respectively. The March data is not yet available.

The strategy to hold more cash could potentially affect the performance of the local bourse, particularly blue-chip stocks.

Jeffrey Ng, head of Malaysia research and strategy at JP Morgan in Kuala Lumpur, tells , “Our view on the FBM KLCI is premised on local institutions deploying cash.”

Nevertheless, he thinks the high cash levels may not persist, given the aim of unit trust funds, which is to maximise performance.

At end-February, the highest allocation was to the IT sector (15%), followed by consumer (13%), industrials (12%) and financials (12%). Based on stock exchange data, local institutional investors have been net sellers in the crude palm oil, technology and banking sectors year to date, says JP Morgan.

Year to date, local institutions were net sellers to the tune of RM7.38 billion, according to MIDF Research’s April 11 report. Foreign funds, on the other hand, have been net buyers in 12 of the first 14 weeks this year, with net inflows amounting to RM6.97 billion.

Thomas Yong, CEO of Fortress Capital Asset Management, says that while certain unit trust funds are required to stay invested with high equity weights, those that have more flexibility might maintain high cash levels in the near term given the uncertainties in geopolitical developments, high inflation and hawkish stance of central banks.

“Commodity prices are expected to stay high if the Russia-Ukraine war is prolonged, and this is causing high inflation, especially in the food and energy sectors. The major central banks may become more hawkish and tighten policies at a faster pace,” he says.

In recently released data, the US’ headline inflation expanded at the fastest pace in 40 years, surging 8.5% year on year in March. As a result, UOB Global Economics and Markets Research expects the federal funds target rate (FFTR) to be hiked faster by 50 basis points (bps) at the Federal Open Market Committee (FOMC) meeting in May.

“We continue to expect 25bps at every remaining meeting of this year. Including the March FOMC’s 25bps hike, this implies a cumulative 200bps of increases in 2022, bringing the FFTR higher to the range of 2.00%-2.25% by year end,” it said in an April 13 note.

Besides inflation, another concern is that China’s “zero-Covid” strategy has resulted in a number of lockdowns lately, which may worsen supply disruptions and slow down the economy, Yong points out.

Nonetheless, he believes that institutional funds will continue investing in banks as they are beneficiaries of higher interest rates as well as the reopening of the economy. In addition, there is likely to be interest in the trading of commodity stocks on the back of high commodity prices.

“The recovery play will still be intact. Sectors like food and beverage, tourism-related and retail are likely to be in portfolios. However, we shall pick those companies that are able to pass on the higher costs,” says Yong.

Amid the risk of supply chain disruptions due to China’s Covid-19 developments, Ng opines that the market could see local institutional investors rotating out of the technology sector and into commodities.

“Our stance on the FBM KLCI is underpinned by commodities’ larger weightage relative to technology,” he says while maintaining an overweight stance on plantation and commodities-related equities.

Ng advises investors to relook at reopening plays, such as Genting Malaysia Bhd. The research house also prefers Hong Leong Bank Bhd, Sime Darby Plantation Bhd, Kuala Lumpur Kepong Bhd, Press Metal Aluminium Holdings Bhd and Petronas Chemicals Group Bhd.

While the long-term prospects of the technology sector are favoured, he maintains a neutral stance in view of the near-term risk of supply chain disruptions. “It will be important to monitor the PMI (purchasing managers’ index) report — particularly with regard to inventory (quantity of purchases) and delivery time, port congestion in China and spot freight rates — to see if there are any signs of supply chain bottlenecks intensifying,” he says.

Areca Capital Sdn Bhd CEO Danny Wong believes that tech stocks continue to be attractive at their current levels. “The high cash holdings among unit trust funds were partly due to the sell-off in technology stocks, which are sensitive to upward revisions in interest rates.

“Although funds have been selling technology stocks, we are talking about the valuations and long-term trends. With attractive valuations, it is highly likely that funds may re-enter the technology space.”

For funds that are holding too much cash, he cautions that they may lag behind when the market rebounds. “When funds start to deploy cash, you will see the market being elevated by them. Banking and consumer stocks are the main themes in line with the recovery and reopening plays. Some may have short-term thematic plays, where they go into commodities because of inflation and the war that have pushed up oil and raw material prices.”

Overall, Wong sees attractive risk-reward in Southeast Asia amid trade diversion from the China-US trade war as well as the Russia-Ukraine war, including Malaysia, which has been a laggard over the past few years compared with its peers.

“There is a stagflation risk in the developed markets. Southeast Asia seems more appealing to them in terms of the risk-reward ratio. As foreign holdings are low in Malaysia, we don’t see a high risk of them flowing out. The ringgit is also quite attractive at the current level,” he explains.

As earnings growth in developed markets slow down, foreign investors are likely to look for markets with higher growth, says Yong. “This year, we are seeing higher economic growth in Southeast Asia compared with other developed countries, due to the reopening of the economy and low-base effect last year.”

Ng is of the view that the inflow of foreign funds to Malaysia will be sustainable as the global sector rotation into commodities benefits local equities. On the impact of US interest rate hikes, he notes that central banks in emerging markets (EM) will keep a close eye on interest rate differentials with the US.

“Thus far, credit spreads and currency markets indicate limited pressure despite EM-US interest rate differentials remaining relatively low. Having said that, the pressure will likely build if the Fed moves more aggressively. This may also lead to a stronger US dollar, which is typically associated with weaker Malaysian equities.

“JP Morgan has revised its forecast on US interest rates and now expects the FOMC to arrive at a neutral rate of 2.5% by year end, with 50bps moves at each of the next two meetings.”

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