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Michael L. Avery
Chief Investment Officer
Co-Portfolio Manager
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Ryan Caldwell
Co-Portfolio Manager
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Jonas M. Krumplys, CFA
Assistant Portfolio Manager
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Aaron D. Young
Investment Analyst
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Ivy Asset Strategy Fund - June 2010
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With China’s stock market down roughly 20 percent this year, it’s only natural to question Asset Strategy’s continued investment positioning in China, particularly amid the recent global equity volatility tied to southern Europe’s sovereign debt crisis.
For several reasons, despite the market’s downturn, our view on China hasn’t changed. In fact, the decline in equity prices has expanded investment opportunities, as valuations on many stocks appear more attractive to us than they did just a few months ago. At the same time, China’s policy steps in recent months have confirmed our confidence in the country’s growth sustainability.
Given the recent global volatility, it’s important to reiterate that we maintain a long-term investment view. With that view, day-to-day market volatility takes a backseat to actions we think will produce the best long-term investment results. And our view remains that investing in Asia, an area of burgeoning growth with 2/3 of the world’s population, offers the world’s best long-term investment opportunity. As a result, we maintain a significant structural overweight in China, one that differentiates us from many of our competitors in the global asset allocation space.
Factoring policy risk
We would characterize the latest global equity retreat as a “growth scare,” as opposed to the beginning stages of another global recession. We think the volatility primarily has reflected questionable secular policy decisions in some developed markets. While we feel the corporate side of the economic equation has responded well to the global financial crisis of 2008-09 – with companies generating substantial cash in the process – policy makers continue creating volatility risk.
The global market’s downturn in early May began when the European Central Bank did not make clear its intentions regarding the manner in which it might address debt problems in Greece, Spain and Portugal. To a smaller degree, the lack of policy clarity regarding financial institution reform and other issues in the U.S. also creates uncertainty for global markets.
Quite frankly, China’s policy makers have reacted in ways that make a lot more sense to us than their counterparts in the U.S. and Europe. Consequently, the potential for a policy mistake currently appears higher in the U.S. and Europe than China.
It appears China’s central government officials have learned from past policy mistakes, such as their decision to raise interest rates heading into the global financial crisis. Heading into 2010, China anticipated continued economic growth as the result of increased consumption and fixed asset investment. It did not expect substantial export growth as the global economy continued recovering in a muted fashion. However, China’s export growth has surpassed expectations, and the central government’s fixed asset investments pushed property prices in large cities substantially higher. The result: the country’s economy began overheating.
The central government reacted not by raising rates, but by tightening on the edges. It scaled back its fixed asset initiatives, and property transaction volume virtually has halted. Fears of a property price bubble have eased; with transaction volume down, prices should follow. In addition, inflation – a constant concern of investors in China
– likely will peak at 4 percent within the next two months we believe.
Pullback Creates Opportunities
Nonetheless, because of China’s tightening measures and worries about property prices, investors in China’s market essentially have priced in a recession, even though we anticipate the country’s gross domestic product to rise by 8-9 percent in the last half of 2010. In spite of the broad market’s view, China’s economy continues growing at a consistent pace, and consumption remains stable.
Meanwhile, the slide in China’s stock prices has pushed valuations almost to the levels last seen during the trough of the global financial crisis 18 months ago. At June 16, Hong Kong’s Hang Seng Index was trading at 1.67 times book value, a level that traditionally has provided good investment value.
In short, given the economic outlook and current valuations, China presently offers an appealing risk/reward tradeoff. Moreover, historically, when China’s market has suffered a decline of 15 percent or more, it has rebounded more than 40 percent six months later, though there are no assurances that past performance will be repeated.
With the current environment offering what we feel are good opportunities in a part of the world that we think offers the best long-term global growth prospects, an overweight in China appears justified. We’re attentive about reassessing the position should conditions change. If, for instance, the GDP growth outlook fell considerably, we would reduce our weighting in China.
But for now, the key factors – China’s policy vigilance, its attractive valuations, its long-term growth prospects – all argue in favor of continued investment allocation to firms that may be benefiting from China’s growing economy.
The opinions expressed are those of the Fund managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through June 16, 2010, and are subject to change due to market conditions or other factors. • The Fund allocates from 0-100% of its assets primarily among stocks, bonds, and
short-term instruments, across domestic and foreign securities.
International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. • With regards to fixed income securities in which the fund may invest, these are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. • Because the Fund may concentrate its investments, the Fund may experience greater volatility than an investment with greater diversification. • The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk. • Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. These and other risks are more fully described in the Fund’s prospectus. • Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.