Cash is now a viable investment option for the first time in many years, and its appeal will draw money from other asset classes leading to poor performance both in financial assets and the real economy, according to Greg Jensen, co-chief investment officer at global investment management firm Bridgewater Associates.

Facing this scenario, investors should re-think their portfolios beginning with a the risk neutral position of cash before considering whether to layer on passive investment – or beta – and possibly some active views for alpha, he said.

“The risk neutral position in cash is actually relatively attractive compared to beta,” Jensen said, speaking with Colin Tate, managing director of Conexus Financial, at Conexus Financial’s Fiduciary Investors Symposium in Singapore.

“Essentially there’s very low risk premiums priced into most asset classes,” he said. “That means the benefits of taking risk relative to cash are low relative to history.”

A range of headwinds will make markets less beneficial for assets in the years to come, Jensen said.

We are moving from a world of globalisation and integration to a world of conflict and fragmentation, he said. This world is less productive and more inflationary than the markets investors have come to know, with greater government intervention and populism, and the rising need for enormous investment in climate initiatives.

Central banks and fiscal policymakers that have been innovative and active will be constrained by high inflation and debt levels, he said.

After a “huge pulling up of cash flows” over the last decade, asset prices are now extremely high relative to cash flows generated by economies, Jensen said, noting the last time the gap was this large was in 1975.

“The last time assets were this high relative to cash flows, you ended up with assets being flat for five to seven years and inflation driving nominal GDP to catch up with those high asset valuations,” Jensen said.

NORMAL RELATIONSHIP BETWEEN CASH FLOWS

Nominal GDP could exceed returns on asset prices for a long period of time as markets return to a normal relationship between cash flows in the economy and financial assets, which would make the coming years a “very rough time for financial assets,” he said.

And with cash returns reaching “extreme levels” compared to 10-year yields, 30-year yields, corporate debt and earnings, cash is now a viable choice for the first time in many years, Jensen said.

“That’s a big deal because that’s going to gradually draw money from other assets into cash,” Jensen said, meaning assets are likely to do relatively poorly compared to cash.

Facing this situation, it will be important for investors to stress test for various scenarios. This could be recession, it could be central banks losing their nerve and allowing inflation to rise, or it could conversely be that monetary tightening works and markets end up with a “Goldilocks” environment.

Investors need to consider how to protect their portfolios against the possibility of long term inflation, as the threat of long term inflation is not reflected in long term asset prices, which means “there is still a large risk that asset prices will decline as a result of a recognition that inflation won’t just go back to target,” Jensen said.

They also need to consider geographic balance, with history showing countries that do well in one decade tend to do less well in the subsequent decade.

And they should seek out good diversified alpha by finding managers that have a low correlation to their portfolio.

“Most people aren’t doing enough to say: ‘What are my alpha sources, and are they negatively or zero correlated to my portfolio?’” Jensen said. “If so, crank those up.”

The challenges currently outweigh the opportunities in many classes of real assets, and funds have billions in dry powder waiting for better deals, but strong fundamentals will ultimately prevail in the long term, said the head of asset manager Nuveen’s real assets business.

The listed real estate sector was last year “trading at some of the biggest discounts we have seen to reflect the rise in rates and other geopolitical events,” said Mike Sales, chief executive of Nuveen Real Assets. But private assets still need more time.

In a discussion with Patrick Kanters, global head of private investment at APG in the Netherlands, Sales said there is a lot of dry powder sitting on the sidelines–around US$8 billion in Nuveen’s case–waiting for signs of distress or better opportunities.

“We are not investing at the moment unless we see some form of distress, or prices in our calculations reflect where we think the market should be today,” Sales said.

In a panel discussion exploring the benefits of real assets at Conexus Financial’s Fiduciary Investors Symposium held in Singapore, Sales said global population growth may be slowing but it is still a major contributor to the value of land-based resources, with senior housing needs in particular set to rise as the over 80s demographic explodes in the coming 10 to 20 years. 

The ongoing digital transformation is driving the need for data centres and logistics which are responsible for enormous growth in real estate and had delivered “incredible returns” over the last five years, he said.

There is also a rising global challenge to provide sustainable food, fibre and timber systems, and offer solutions to the challenge of eliminating net carbon emissions.

However while the sector does offer some level of hedging against inflation, inflation and rising rates have taken their toll by driving up the cost of debt by more than 300 basis points, he said. Patience is currently the game as the full impact of interest rate hikes has yet to sink into some sectors, particularly private real estate.

“Long term they are great asset classes to be in, but the right entry point is important and we’re not quite there yet,” Sales said.

APG–with close to €630 billion in funds under management–invests in real estate, infrastructure and natural capital which includes timber-producing assets and agricultural land, with roughly a third of its real assets portfolio in each of the three regions of Europe, the Americas and Asia-Pacific.

ATTRACTIVE TRANSACTIONS

On the topic of renewable energy, Kanters said APG still sees attractive transactions in the US whereas “in Australia more recently we are being priced out by 20% or so.”

There are some opportunities in renewables for large funds willing to monitor many transactions, stay selective and underwrite some development risk, he said, “but we are far more selective the past two years or so.”

“If you look at how much time I have spent over the last two years instructing the team: ‘You can wait a bit, sit on your hands a bit, the best years are still to come, plant a few small seeds for new platforms to make sure the money is sidelined and is there when the opportunities are there,” Kanters said.

The fund is committed to responsible investing, and “we are convinced we can make money by implementing that properly both regarding physical and transition risk,” Kanters said.

APG has €55 billion of listed and private real estate spread over different sectors, and has been disposing of retail and office assets while favouring alternative real estate such as student housing and healthcare facilities.

The fund’s co-plan strategy demands managers are able to catalyse returns based on one or more mega trend.

“That’s why you see us more and more in alternative real estate,” Kanters said. “That will, in time, become the traditional asset sectors.”

The fund’s natural capital assets are a relatively small portion of the portfolio at about €2.6 billion, and form a part of the fund’s impact investing.

After more than a decade of high-priced bonds, fixed income is now compensating investors more than many asset classes, argued Raymond Sagayam, chief investment officer, fixed income at Pictet Asset Management in the United Kingdom.

Speaking in a panel session titled ‘The renaissance in fixed income’ at Conexus Financial’s Fiduciary Investors Symposium in Singapore, Sagayam said markets had priced in unrealistic expectations that there will be a “ladder of de-escalation” in interest rates, arguing rates are likely to plateau at a high level for some time.

He also pointed to equity earnings yields contrasted with 10-year bond yields and argued investors are “not getting compensated” for the high price of equities, and “the last time we saw the equity earnings yield down at these levels was back at the GFC.”

Predicting a lot of pain still to come in equity markets, he said he was an advocate of shifting “from equities into fixed income assets in general.”

But he is not blindly advocating investors lap up everything in the fixed income universe, he said, noting he was concerned about full maturity credit funds and felt “there will be a much better opportunity to gain exposure towards the end of this year, maybe early next year.”

But two areas he is very bullish are short duration funds and cash, which is “now an asset class in its own right” with different options investors need to understand.

He also pointed to emerging markets where interest rate differentials are wider than in developed markets.

“The emerging central banks have been far more aggressive at hiking interest rates, they’ve been doing it early, it’s at a much higher magnitude, so you’re getting compensated,” Sagayam said.

Emerging currencies are also the cheapest they have been in 40 years relative to the US dollar, he said.

INFLECTION POINTS

Farouki Majeed, chief investment officer at Ohio School Employees Retirement System in the United States, said the last two years saw inflection points where investors could take advantage of macro changes.

It was “unusual” that his fund made the decision to be underweight equities and fixed income over this period, but it was a “fairly easy call to say both of these assets are going to face very strong headwinds,” Majeed said.

The fund ultimately saw a return of negative 5.6% in 2022, which was better than a lot of peers.

“If you were a 60/40 investor in 2022, 60/40 would have given you a return of negative 16%,” he said. “Many of my peers had double digit negative returns in 2022. This was a period where making some bold macro calls could have benefited value addition in a portfolio quite a bit.”

The fund is still holding to those positions but “the ones that I would first probably want to think about correcting is fixed income,” he said.

Majeed said he agreed with Sagayam that terminal interest rates could go higher still and remain high for longer than some expect, and that the short duration end of the fixed income market is attractive, while reserving judgement on longer duration plays.

“As far as equities are concerned, I am more cautious about equities at this point in time than fixed income, so we might be more underweight equities for a longer period of time,” he said, arguing financial assets will have a “pretty challenging time” for the next one to three years and the 60/40 portfolio “may have to be flipped the other way around” for the near term.

Three major trends have converged to drive growing appeal in new alternative data classes of quantitative investing, according to a leading quant researcher.

“Quants like us who were in the right place at the right time in history can take advantage of the confluence of these three major secular trends,” said Mike Chen, head of alternative alpha research at Robeco in the United States.

Speaking about finding alternative alpha at Conexus Financial’s Fiduciary Investors Symposium in Singapore, Chen said the amount of data in the world is growing exponentially. Algorithms have become very powerful, with some highly sophisticated algorithms free for consumers to use, such as artificial intelligence chatbot ChatGPT. And the computing power required to run these algorithms has arrived and is getting faster.

Chen gave examples of some of the developments in the market as quant investors seek to stay ahead of the game.

Company executives, aware their conference calls with investors are being fed into algorithms, have long been coached to use positive and bullish key words to trick the quants.

But vocal chords, made up of 47 separate physiological mechanisms, are much harder to train, Chen said. Some algorithms are now converting audio recordings into spectrograms and using this to detect a person’s underlying emotional state.

“You can compare that against the words that they say,” Chen said. “Are they in agreement or are they not? Their intonation, pitches, volume, pauses, all that information can be analysed.”

Patterns of interaction

Machine learning is also detecting patterns of interaction between market participants and stock prices, such as decoding the mysterious ‘reversal effect’ where stocks rebound or ‘bounce’ somewhat after sharp inclines or declines. The fact that they do not do this on some rare occasions was long thought to be a “statistical fluke,” Chen said, but it is actually related to the news volume surrounding the event that caused the rise or fall.

“When there’s a huge amount of news that’s happening related to given company, when that company’s price is going up or down, the price does not reverse,” Chen said.“What this means is that the price movements in those situations where there is a very high or abnormal news volume are actually being supported by factual information, not just being pushed in a vacuum by speculators or FOMO people.”

Language processing can also not only check whether company executives are using bullish language, but also whether they are answering analyst questions directly or evasively, he said.

Also on the panel was Charles Wu, chief investment officer at State Super in Australia. Around seven years ago, Wu began looking at machine learning to complement State Super’s investment process by providing more information to back up investment decisions.

Insights from data can help investment professionals challenge the judgements they make based on the limited experience of their careers when long-term paradigm shifts take place in markets, Wu said.

“It tells us things such as that interest rate differentials may not be your best determinant for a currency movement,” Wu said. “That’s something that we learned during this machine learning process, and that in itself gets us to more useful questions.”

For investors who want to add elements of quant to their investment process, it is important to start small, with clear and well-defined goals, he said. An advisory board of experts from academia can help bridge the communication gap between the board and internal stakeholders who are skeptical of quant, he said.

A slight moderation in inflation statistics, and a rising belief that growth is more durable than expected, has lulled markets into a false sense of security, according to senior portfolio strategist Phil Dobrin at American investment management firm Bridgewater Associates.

Markets are now changing their prices and discounting a future that is at odds with history and very different to Bridgewater’s own projections, Dobrin said, speaking at Conexus Financial’s Fiduciary Investors Symposium in Singapore.

“Markets are expecting Goldilocks, that’s fully discounted,” Dobrin said. “We don’t expect a market crisis like Lehman, but we do expect a lengthy recession that’s hard to pull ourselves out of.”

Markets are in the midst of an earnings bubble, and there is a disconnect between the earnings seen in listed companies and the health of the broader economy, Dobrin said.

Markets are also signalling there will be several more monetary tightening rounds then a full “candy cane” turnaround as inflation falls, with rates back towards a regular cycle at the end of 2024, Dobrin said. Earnings growth is expected to do a brief pause before descending to new heights.

This is unlikely, he said. “There might be a world where inflation is around the two-and-a-half percent target that central bankers have for it, but that world seems very incompatible with a world where earnings are going to resume their upward climb.”

MONETARY TIGHTENING

The monetary tightening cycle of 2022 was far in excess of anything markets expected, he said. But while the first order effects of that tightening had been priced in somewhat, markets had not priced in the second-order effects such as the ongoing impacts on cash flows and assets.

Pricing had become “pretty extreme” after a “relief rally” on the back of slight improvements off terrible levels of inflation.

“Some people talk about a soft landing, I think if you look at the markets today I would say what’s discounted is more of a perfect landing,” Dobrin said.

It would be extremely unusual to see a monetary policy U-turn that was not followed by a recession, he said. More easing is discounted today than in 2020 at the onset of the pandemic, or in 2008 during the global financial crisis, he said.

Bridgewater is skeptical of some views that China’s re-opening will help markets achieve a soft landing. It is more likely to fan the flames of global inflation than global growth, as it will increase global consumption without increasing production, he said.

Margins are contracting and profits are likely to start declining in the near future as the effects of pandemic stimulus wash through the system, he said.

Dobrin said deflationary growth is not much to worry about, as there is “tremendous room” for policymakers to stimulate with quantitative easing and marry this with fiscal policy. But there is much more risk when inflation is high and at odds with the ability to stimulate.

“That’s very much where we are,” Dobrin said. “When central banks are constrained, assets can fall, and they can actually stay down without central banks being able to rush in and ease.”

There is no such thing as deglobalisation, and the reshaping of global trade amidst increasing protectionism is simply globalisation taking a different form, according to the chief economist at the asset management arm of two-century-old Swiss bank Pictet.

Patrick Zweifel, speaking at the Fiduciary Investors Symposium in Singapore, said this new form of globalisation would send huge benefits to Asia and see regional trade and GDP grow faster than the rest of the world.

Trade in goods as a proportion of GDP rose globally from the 19th century to finally peak in 2008, before this ratio began to decline. This falling trend is likely to continue, even if there was a rebound in 2022, Zweifel said. But at the same time there has been a booming increase in services which are growing at a faster pace than goods.

“That’s just the beginning of a new trend,” Zweifel said. “The new wave of globalisation is precisely on services.”

There is no real need any more for these services to be delivered face-to-face, owing to technological improvements that were catalysed by the pandemic, he said. This will send opportunities in many services sectors to lower-cost markets around the world, just as goods production was outsourced globally from the 1970s.

Limits to re-shoring

There are limits to the re-shoring that is happening currently as companies seek to shore up their supply chains and guard critical technology, Zweifel said, arguing he is “a strong believer that the principle of competitive advantage will prevail.”

“Companies will continue forever to find places where they can benefit from lower wages,” Zweifel said. “I’m not sure [re-shoring] is a long-lasting process.”

Globalisation of services will be positive for the Asia region which has already benefited hugely from global outsourcing of manufacturing, he said. Asia is highly connected through various free trade agreements, most recently the Regional Comprehensive Economic Partnership which will increase trade across the region.

It also is highly diverse, with wealthy countries with ageing populations–such as Australia, New Zealand, Taiwan, South Korea and Japan–providing capital to the more dynamic, younger populations in South-East Asia and South Asia. India is already the world’s biggest exporter of business services but other countries in the region are also growing their offerings quickly.

Asian markets should, and will be, much more reflected in global indices in the years to come, he said.

And China’s Renminbi will rise in dominance, he said, pointing to the fundamental factors that existed when the US Dollar overpassed the Sterling, including size of GDP, size of the market, and relatively low volatility.

Looking at this history, the Renminbi has “all the fundamentals that can make it a reserve currency,” and “should already be 18% of FX reserves,” Zweifel said.

But this has not happened because “the Renminbi is not fully convertible, there are lots of capital controls, and these need to be removed to see it developing as a more international currency.”