Global trends are leading asset owners towards a new era of investing, argues the Investment Management Corporation of Ontario, IMCO, in a new research paper. One where it becomes increasingly difficult to rely on the past as a predictor of the future.
Primary themes that IMCO expects to play a significant role in driving returns over the coming decade represent an “inflection point” or reversal of previously entrenched trends. Examples include the end of “low for long”, a shift away from globalization towards on-/friend-shoring and increased reliance on the fiscal policy lever relative to monetary policy tools.
“The tides are now shifting, as politicians prioritize domestic employment as a means of addressing inequality. After decades of relative wage gains, emerging markets’ labour cost advantage has waned making the decision to move production to domestic shores easier for global businesses,” says the report.
That resulting disruption will likely be more severe for China than for the US, as China relies more heavily on the US for imports and external demand than the US. Globalization drove the steady decline in costs and prices worldwide over the past several decades, and its reversal, or slowing, could impart inflationary tailwinds as the world heads into a new macroeconomic regime.
In this new world, investors could stand to benefit from a greater exposure to inflation-sensitive assets such as regulated infrastructure, inflation-linked bonds, and commodities. Other economic and market implications include greater volatility, an expected capital-intensive investment “boom” and a growing scope for unintended or undesired passive exposures – all of which can shape investors’ decision-making at the strategic and/or active levels.
Elsewhere, fiscal levers and real economic priorities will take growing precedence over monetary policy and its financial variables of focus, predicts the report. Europe has the potential for the greatest change, as it wrestles with the challenges of a shared currency.
The potential for “stranded assets” will rise as governments, companies and consumers increasingly adopt cleaner technologies and energy sources at the expense of legacy ones. For example, new environmental rules and/or changing societal preferences could put conventional oil production at greater risk. The notion of climate-related winners and losers is also likely to arise in terms of geographies, with some locations better able to withstand and/or adapt to changing temperatures and weather patterns. As an example, some agricultural activities might shift to relatively cooler areas, or real estate along coastal areas could face elevated risks from rising sea levels relative to those located further inland.
Governments’ push to decarbonize economies as part of climate change mitigation efforts will be expensive, requiring significant capital investments as well as new technologies. Government interventions such as carbon pricing and other policy measures are also likely to drive up energy prices, adding further tailwinds to the global inflationary trend.
Advances in computing, automation, and other technologies have continued to accelerate. The increase in innovation has become global in nature, with advanced and emerging countries pushing technological frontiers.
This technological disruption is no longer confined to a limited number of market segments such as the software, hardware, and pharmaceutical industries, however. Industries that were not prone to disruption have also been affected. For example, the increase in on-line shopping and home delivery over the last decade has pushed established retail companies into bankruptcy and weighed heavily on retail real estate valuations. The world is only just starting to witness some of the disruption that these developments will bring to large segments of the global economy.
More generally, these technological advancements have coincided with the concentration of gains amongst a narrowing group of firms, consistent with the rise in importance of network effects within many emerging – often digital – sectors and the increased prevalence of winner-take-all competitive dynamics. When such economics are at play, the related value creation tends to flow to first movers and/or those who manage to become the “standard” setters, states the report.
Growth in private markets
Attracted by the resulting potential for superior risk-adjusted returns, a growing number of institutional investors are dedicating resources to private markets. At the same time, demand for/supply of such financing is growing as post GFC regulations have encouraged a move towards private market-based financing over traditional bank-based sources. The net result has been an expanding pool of investment capital seeking a similarly expanding set of private market opportunities. This trend is expected to continue as suggested by estimates from Preqin – a firm specializing in alternative assets data and insights – which foresee private capital assets under management (AUM) increasing at a rate of nearly 15% per year to approximately $18 trillion by 2026.
However, index investing’s growing popularity among retail and institutional investors masks the growing risks associated with these passive exposures, flags the report. It is prudent to continue to build the ability to provide index-based exposures in ways that align with investors’ ESG beliefs and limit the potential for undue concentration risk.
Finally, the report argues that idiosyncratic country drivers highlight the need to look beyond broad, relative economic growth rates – both past and prospective – when evaluating potential investments. History suggests countries’ GDP growth rates and domestic equity market performance exhibit only a very loose relationship over the past couple of decades. Clearly, other factors also matter and point to the need for a thorough assessment of potential returns, risks, diversification benefits and investors’ own abilities to outperform.
For these reasons, a research-driven investment process that allows investors to monitor and respond to the changing world around them is imperative.