The term lost decade, or lost decades, is generally used to describe the lengthy period of economic stagnation in Japan that began around 1990.
For three decades, this once great economy flailed, encumbered by falling asset prices, natural disasters and the country’s rapidly ageing population.
Now, other nations are facing the possibility of lost decades of their own, with a growing number of economists and investment experts seeing recession as the base case, and many doing analysis for an extended period of stagnation – an environment in which few assets do well.
It’s a scenario that’s keeping John Greaves, the director of fiduciary management at the £34 billion ($45 billion) UK pension scheme, Railpen, up at night.
“I’m increasingly really worried about a lost decade in terms of real returns and not many of us have experience managing through that, but it can absolutely happen,” he said at the Top1000funds.com roundtable on geopolitical volatility and portfolio resilience.
“What does that stress test look like, when over 10 years, you earn zero real return?”
Steven Fox, executive chair and founder of political risk consulting firm Veracity said that the possibility of a lost decade, particularly in Europe, looms large but could potentially be curbed through regulatory reform.
“The European and US economies were about the same size in 2008 but today the US economy is roughly 40 per cent larger than the Eurozone,” he said, citing over-regulation in Europe as a key reason.
As an example, Fox pointed to the rebuilding of the Notre Dame Cathedral in France, which took just five years to complete.
“If normal regulations had been followed, it’s estimated that it would have taken 20 years to accomplish but they suspended all regulations except health and safety and got it done in five,” he said.
“That is an indication of how dramatically overregulated Europe is and, until that changes, the lost decade, certainty in this part of the world, is very much going to be with us.”
Liz Fernando, chief investment officer at £50 billion UK pension fund, NEST, said there are encouraging signs of change in Europe and increasing recognition of the importance of investing for growth.
“There’s a great danger that what gets hidden behind all the noise and focus on the US is Europe – and particularly Germany, which has done some pretty incredible things post-election, [such as] the idea that the debt brake is effectively going to get thrown out,” she said.
“Europe, in some ways, has been given the boot up the backside.”
Kate Barker, chair of the trustee board at the £77.9 billion Universities Superannuation Scheme, said discussions about a potential lost decade were extremely important, particularly in the context of weak global productivity growth, which had significant implications for global economic growth.
“We’ve been through a period where we’ve had no, or very little, productivity growth in Europe, and it’s quite surprising that almost every country has experienced the same thing. You might have expected more variation,” she said.
“Much investment money has been made in the US… and it is not really clear to me where the returns will come from in the next decade.”
Regime change
According to Greaves, the market’s reaction to announcements made by the US administration in early April, provides further evidence of a regime change.
“I’m a strategist by background so I try to always think long-term, but recent events are further evidence, for me, of a change in regime and a change in how economies are going to behave and how markets are likely to react, which requires a change in my thinking,” he said.
“The thing that’s really concerning at the moment is what’s happening with the portfolio diversifiers… what’s going on with USD and US Treasuries, which emphasises the importance of geographical diversification and thinking carefully through how different parts of the portfolio might behave in different scenarios.”
Regime changes, be they political, economic or social, occur when a system goes out of balance and systemic risks are not addressed, said Luba Nikulina, chief strategy officer at IFM Investors, pointing to the election and re-election of Trump.
“We talk a lot about systems, and when we talk about energy transition, we think about the planet as a system that goes out of balance, and there are systemic risks that don’t disappear,” she said.
“There are several systemic risks we monitor, including social systemic risks that we observed here in the UK during Brexit. And now what’s happening in the US is another manifestation of this social systemic risk.
“When you’re in the midst of it, it’s hard to make significant use of it but, at the same time, it presents an opportunity for investors, provided they have the liquidity to act. This is where risk management comes to the forefront to ensure that you can actually take advantage of opportunities.”
Veracity’s Fox said the signs point to a “long-term sea-change”.
“We have a [US] president who is willing to use relatively unbridled power and an institutional system that doesn’t have the capacity to push back at the present time,” he said.
“I don’t want to paint a bleak picture but it’s a realistic picture that certainly merits a lot of thought, but we can’t get lost in the day-to-day.”
USS’ Barker said a key challenge for institutional investors, given the messy, unprecedented nature of policy changes and the market reaction, was not to react and jump to conclusions too quickly.
“We get very focused on the implications for different countries but we’re thinking about macroeconomics when actually it’s almost certainly going to be implications for different sectors that drives some of the changes to how we invest,” she said.
“Starting from the macro perspective doesn’t seem to be wholly helpful and I think this is a time when you’ve really got to start from the micro.”
For Barker, one main consideration for investors would be around currency.
“Currency views have been thrown up in the air by the events of recent weeks and questions about the US dollar are really significant,” she said.
“We may see moves by the US to suggest different deals on currencies. I’m pretty sceptical about deals on currencies because unless you have exchange control, my view is that they tend to go wherever they wish.”
Buying the dip
Pension and sovereign wealth funds, with relatively steady inflows and longer-term time horizons, appear best able out of all investors to ride out market volatility and buy the dip.
Fernando said for NEST, which receives around £500 million per month in contributions, current market conditions present unique opportunities.
“That’s a really helpful flow of liquidity, which we can use to try and rebalance the portfolio in sensible ways at times, because you’re always buying market corrections and if the fundamentals haven’t permanently been impaired you’re buying the same asset at a lower price,” she said.
“I wouldn’t say we enjoy crises but we probably view them in a different way to funds that are paying out beneficiaries.”
Like NEST, Australian pension fund (locally known as superannuation) REST is strongly positioned, given the fund’s relatively young membership.
At the A$93 billion ($59 billion) fund, around half of the members are under age 30.
Despite having a longer time horizon than most funds, Sonia Bluzmanis, REST’s London-based head of external equities research, said it is still difficult to block out the noise and chaos.
“We’re thinking about how everything that’s going on in terms of geopolitics, capital markets and economics impacts on our long-term capital market assumptions,” she said.
“In the short-term, as much as we would like to look through [the chaos] we can’t, so a key focus for us is liquidity. It’s not that we’re expecting a tonne of outflows but it’s more about having to meet regulatory requirements and ensuring that we’re trying to avoid any uncompensated or excessive risks.”
At the £19 billion Coal Pension Trustees, where nearly all members are drawing their pension and between 7 and 10 per cent of assets are paid out annually, short-term volatility and economic shocks can have a significant impact on the schemes.
Callum Logan, head of investment strategy at Coal Pension Trustees, described his job as equal parts investing and divesting, making liquidity absolutely critical.
“In these difficult times, it’s about relying on diversifying assets that often haven’t been doing as well as public equities in rising markets,” he said.
“Sometimes it has been hard holding those assets when you’ve seen a strong bull market in equities, but you can be grateful for their protection at this time.”
Railpen’s Greaves said a major challenge for pension funds is achieving appropriate geographical diversification.
“There’s often a very favourable outlook for South-east Asian growth for example, but it’s hard to get conviction that translates into corporate profitability on publicly listed markets, because it may or it may not, and you just don’t know,” he said.
“That mechanism is much more established in developed markets whereby public companies can extract growth. While that tends to go to a small percentage of public markets, as long as you’re broadly diversified, you can often feel comfortable in that assumption.”
Being a well-funded defined benefit scheme, Railpen, doesn’t have to invest in everything. It can stick to the assets that it knows and understands to earn a certain level of return, Greaves said.
“That strategic discipline I feel is more important than ever,” he said.
Chris Mansi, chief investment officer, Europe and International at WTW, said one action that investors could take in the short term was to build understanding of the risk in their portfolio by identifying areas of high concentration and considering the potential implications in the case of a “bad event”.
“Looking at things on a micro sector-by-sector basis may make sense intuitively, but it’s a very difficult thing to form strong views as to how things will pan out,” he said.
“It’s also kind of the antithesis of allocating passively, which would point to having confidence in good quality active management.”
While market volatility and signs of entering a period of high inflation and low economic growth theoretically favour active management, Logan said the standard rules and assumptions may not apply anymore.
“In volatile and uncertain times, the thinking goes, you want someone actively looking at [the portfolio] who can be on top of all the live issues and trade day-to-day, but with so much going on, how well placed is anyone to do that?” he asked.
“To me, it’s not conclusive that active management is key here and, at this stage, perhaps it’s better to be asking questions than giving answers.”
“That said, one thing I certainly stand behind is geographical diversification, which our schemes are positioned for. Global market cap benchmarks imply 65 per cent of your public equity portfolio in the US, which does not feel balanced, but whether you implement actively or passively is less clear.”
Coal Pension Trustees has had a regionally diversified approach to asset allocation for a number of years, which Logan admitted had been “painful” at times, given the exceptionally strong performance of US equities over the past 10 to 15 years and, more specifically, the phenomenal performance of US mega-cap technology stocks in recent years.
“Regional diversification is really important and it ties very closely to the currency issue because, ultimately, we’re paying liabilities in Sterling, so we want the benefit of being diversified across different regions,” he said.
“A lot of the investable universe, not just in public equities but also debt and private markets, has been in the US, and managing offshore illiquid assets and the currency around that is challenging.”
“I think it’s early days for the Trump administration and we’re trying to understand what some of these potential changes mean, including is the US dollar the flight to quality it has been and does that warrant a higher hedge ratio? I don’t think that’s a question we need to answer tomorrow, but it’s certainly one that we need to think about.”
