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.”

This time last year, Sweden’s four buffer funds reported the best returns in their history. Fast forward 12 months, and the four funds have  posted losses thanks to allocations to equities and fixed income dragging their portfolios down. It’s left all four funds doubling down on strategies that focus on low costs linked to sophisticated internal management, ESG integration and a keen eye on the long term.

Across all AP Funds, allocations to fixed income and equity suffered most damage, pulled down by high inflation, rising interest rates and war in Ukraine. At SEK421.2 billion ($40.4 billion) AP1, where strategy focuses on robust, active decision-making and a bold risk mandate in a large internally managed allocation, strategy in 2022 focused on pro-actively changing positions including lowering equity exposure and reducing the duration of the fixed income portfolio, said CEO Kristin Magnusson Bernard. AP1 reported a total return of minus 8.6 per cent for the year.

Alternative investments in real estate, infrastructure and private equity funds countered losses in fixed income and equity. Challenging market conditions, particularly the European energy crisis triggered by Russia’s invasion of Ukraine, has had implications for the transition. Magnusson Bernard notes it has resulted in “difficult short-term and long-term trade-offs for societies and corporates”.

Still, like all the AP Funds, AP1 doubled down on sustainability through 2022. For example, one of the components of its new ESG strategy, adopted by the Board in 2021, includes all new investments in private equity should actively contribute to one or more of the global SDGs. In listed equity, the carbon footprint of the portfolio has fallen by 57 per cent since 2019.

AP2

It was a similar picture at SEK407.1 billion AP2 (which reported a loss of -6.7 per cent) where falls in equities and fixed income were also stalled by gains in non-listed assets. Eva Halvarsson, CEO of AP2 noted that despite the turbulent year for both equities and fixed income the portfolio proved more resilient than other indices including OMX Stockholm (which declined by approximately -13 percent during the same period) and MSCI World which fell by approximately -16 per cent.

“Over time, we’ve built our portfolio for situations like the one that arose in 2022,” said Halvarsson. “We’ve placed great value on spreading the risks as far as possible between different types of asset classes and markets, between listed and non-listed assets and between different management models. Our assessment is that, over time, this creates a good and stable return, in line with our long-term mission.”

AP2 has also focused on sustainability, developing new processes to better understand and measure impact. In timberland the fund now invests in line with ten criteria including biodiversity. “This is our latest prioritised focus area within sustainability,” says Halvarsson. The majority of the fund’s timberland investments are in Australia and the USA, in assets that produce saw timber and pulpwood.

AP4

AP4’s bigger loss (-11.9 per cent) left the buffer fund losing its size lead over its three peers, with SEK460.5 billion ($44.1 billion) currently under management compared to SEK527.6 billion ($50.5 billion) a year ago. Equities, which make up 51.7 per cent of the portfolio, where whacked across the board. AP4 has around 17 per cent of its portfolio in alternatives. Elsewhere the portfolio’s CO2 emissions decreased by 3 per cent in 2022 contributing to to a decrease across the whole portfolio of 61 per cent since 2010.

AP3

AP3 ended 2022 with SEK468.4 billion ($44.8 billion) under management and experienced a loss of -5.8 per cent. AP3’s alternative investments returned 8.9 per cent, mainly due to investments in infrastructure and timberland. Elsewhere the fund has focused on developing sustainability goals around corporate governance, climate, human rights, and biodiversity over the last year.

In a recent interview with Top1000Funds.com, Pablo Bernengo, CIO of AP3, explained how the buffer fund is positioned to actively navigate and benefit from volatile markets since a reform process replaced decade-old separate alpha and beta allocations with a traditional asset class structure and appointed new asset class heads.

Long term

Despite the difficult year, all CEO’s see losses in the context of their long-term focus, burnishing long-term return numbers. AP1’s average real return amounts to 5.6 per cent over the past ten years while the fund continues its low expense ratio at 0.06 per cent.

AP4’s Ekvall notes that measured over a slightly longer time perspective, including 2021, AP4’s portfolio has generated a positive result of more than SEK23 billion ($2.2 billion). “If we stretch out the time horizon, to five and ten years, which is more relevant for a long-term investor like AP4, we can report favourable annualised portfolio returns of 6.9 per cent and 9.2 per cent respectively,” he concludes.

 

As British Columbia Investment Management Corporation (BCI), the $211.1 billion asset manager for around 30 Canadian pension funds and insurers, has transitioned to being an active in-house global investor requiring robust systems, processes and specialised expertise, it has also built a value-added, modern centralized trading framework.

In an industry first white paper, the investor explores the benefits and drawbacks of centralized trading for institutional investors, sharing its experiences. BCI argues that an innovative, centralized trading framework provides clients with greater portfolio returns, lower fees, and allows for improved risk management.

“Our framework was designed with a cross-asset mindset to enhance portfolio returns, lower costs and better manage risk,” said Daniel Garant, executive vice president and global head of public markets at BCI where he oversees a $124.7 billion allocation to fixed income and public equity (around 60 per cent of the net assets under management) the bulk of which is managed internally.

“It was imperative that our platform deliver best trade execution, as well as have strong governance to help influence ESG practices with our global financial partners, in addition to streamlining processes, efficiencies, and scalability for our continued growth,” said Garant.

Better decision making

BCI’s centralized, end-to-end trading approach ensures connectivity at the highest levels and enables one cross-asset desk to execute for the entire corporation. Having a complete picture of trading activities, fees, and data allows for better aggregated pricing on total transactions with partners, and further allows for better decision making grounded in centralized data sources.

Promoting collaboration in what is typically a siloed function at many large institutional asset managers, BCI’s centralized trading framework also shifts the role of the trader from operations to advisor, allowing trading professionals to add significant value to the investment process.

Samir Dhrolia, senior managing director, global derivatives, trading and indexing portfolio management explains more. “Joining BCI at a time when the corporation transitioned to active management allowed me to lead a trading team implementing processes and frameworks from scratch. There has long been an established, back, middle and front office approach to trading, coming in to create something new without legacy frameworks to constrain us was very exciting.”

key benefits

As outlined in the White Paper, the key benefits of a centralized trading framework include:

Cross-asset view that enhances portfolio returns, reduces costs and allows for better risk management.

A central voice facilitated via BCI’s One Wallet platform, a relationship management tool that manages a total view of payments across BCI, negotiating with external parties for the best possible results for clients on commissions, deal flows and third-party services. This is increasingly important as BCI’s operations spans the globe with teams in Victoria, Vancouver, New York, and this year, London, UK

Fosters a performance-focused team, and offers an environment where employees collaborate across the portfolio management, cross asset risk and liquidity functions

Streamlines processes, effectiveness, and scalability for continued growth

Optimizes management oversight, and strengthens legal, compliance and operational controls thus reducing a variety of operational and investment risks

Best practice

The paper details how best practices to implement centralized dealings comprises governance, regulatory requirements, defining order types and cross-asset best execution. The analysis draws on the existing body of research for trading desk structures, industry trends and scenario analysis to estimate the benefits net of costs. It also draws on case studies from global asset management firms.

BCI says continuing to invest in its internal capabilities is the most significant lever it has for reducing total cost for clients of value-added active management.

Costs

BCI’s total costs, consisting of internal, external direct, and external indirect costs, were $2.2 billion or 1 dollar and 8.1 cents per $100 of assets under management for fiscal 2022, all of which are netted against investment returns. This compares to total costs of $1.6 billion or 88.5 cents per $100 in fiscal 2021.

The increase in costs was driven primarily by strong performance and value-add in private equity and real estate, which resulted in higher external costs on the proportion of assets managed externally. While strong performance results in higher fees paid to external managers through profit-sharing agreements, our clients retain most of the value added by these managers.

BCI’s $78.0-billion fixed income program accounts for 37.0 per cent of net assets under management. The $64.3-billion public equities program represents 30.5 per cent of net assets under management. Private equity represents $24.8 billion and 11.8 per cent of net assets under management.

A move away from “naïve engagement” between the US and China affords the opportunity for genuine diplomacy and stabilising relationships over the longer term according to Professor Stephen Kotkin, senior fellow at Stanford’s Freeman Spogli Institute for International Studies and the Kleinheinz Senior Fellow at the Hoover Institution.

Speaking to Top1000funds.com in a video interview on the anniversary of the Russian invasion of Ukraine, Kotkin said a significant armed conflict between the US and China is the “real” geopolitical risk and must be avoided because of its broader systemic impact.

“Geopolitical risk is exaggerated for the most part, most geopolitical risk does not affect markets in the way analysts claim,” he says. “The consequences on a humanitarian level are vast but on an investment level they can often be ignored. With China though it is much larger and systemic and so investors can’t ignore it.”

“I was never one to think that globalisation was at risk but I was one to think that China’s role in globalisation was going to shift radically, that trend was apparent before Russia’s full scale invasion of Ukraine and it has accelerated since.”

Kotkin, who is also the emeritus Professor in History and International Affairs at Princeton University, where he taught for 33 years is a world expert in geopolitics and authoritarian regimes including Russia.

He said amid all the atrocities, as well as the heroism, the Ukraine war has two invaluable achievements: it demonstrated both to China and to the West just how much strength the West possesses, and it showcased an outcome no one should want.

“This is no guarantee of statesmanship.  It is, though, a basis for it,” he said. “One can, justifiably, be both more pessimistic and more optimistic at the same time, as a result.”

Kotkin said there were many surprises as a result of the conflict in Ukraine including Russia’s ability to withstand the sanctions. Althought hard to measure accurately he said Russia’s GDP decline was probably 2-4 per cent last year and may even see growth this year, while Ukraine has lost at least a third of GDP.

“The biggest surprise for me is the absence of another area of the world that has tried to take advantage of the situation, that has tried to do something while the world was distracted by Ukraine,” he said. “That hasn’t happened so that has been a pleasant surprise. It shows you have to be careful and humble with your forecasting but it also shows we are early in this war and there is much more that could come including economic dislocation.”

The use of technology has the potential to transform the investment industry bringing down the cost of asset management, exponentially increasing innovation and building more resilient and adaptive portfolios. So investors need to move now to keep pace with the change. Amanda White talks to Herman Bril about why investors need to become ‘technologized investors’.

At the beginning of this year MSCI teamed up with Google to build a cloud-native investment data acquisition and development platform using Google’s AI and natural language processing technologies. The idea is this will allow MSCI to “acquire, ingest and process” structured and unstructured data at scale and more quickly than ever before.
It’s an example of the use of technology by finance firms to revolutionise their operations and result in the ability to be more productive, have broader analysis and build bespoke strategies at lower cost. Ultimately they can serve their clients better, quicker and with more bespoke offerings.

According to Herman Bril who with co-authors Georg Kell and Andreas Rasche, published a new book in December 2022, Sustainability, technology and finance: Rethinking how markets integrate ESG, these tools and data sets are changing the landscape in profound ways and driving down the marginal cost of asset management.

“We can build tools and put technology in place to build bespoke investment strategies in 15 mins. We are getting closer to autonomous asset management which is highly bespoke and can reflect preferences and values for investors. Five or 10 years ago that would be a big job with an army of people, that is changing,” Bril said in an interview with Top1000funds.com.

The book written with a swathe of contributors looks at three broad topics ESG and technology, ESG through technology and ESG as technology.

Becoming a technologized investor

According to Bril the data available to investors today is transformational compared to the finance industry of old.
“The whole technology stack available today allows for insightful analytics,” he says. “Besides the standard ESG rating disclosures you also have access to lots of different alternative data sets. The question is how do you take that into your systems and benefit from that? How do you build insightful information with all this data suddenly available?”

Bril, now head of sustainability and climate innovation at PSP Investments, acknowledges that the data points are not “perfect” but with so many different data points available from different angles due to natural language processing, machine learning and AI “you can allow for a bit of noise in the data”.

“AI is better than humans in identifying connections and trends in a massive amount of data. We were not able to do that back in the days using excel spreadsheets.”

Bril is empathetic with the call to action by Stanford University’s Ashby Monk for investors to become “technologized”.

“Becoming a technologized investor is really to say asset managers and owners need to become more like information technology companies than traditional investment companies and start using different tools,analytics and data sets.”

This means hiring people with completely different skill sets from the traditional finance analyst sitting behind Bloomberg, and instead look for those who can code, data engineers and climate engineers.

“That is driving massive change in the asset management industry and is ongoing. More and more organisations are making big improvements and investing a lot of money to become technologized investor.”

The book has contributions from many technology experts including Ashby Monk and Dane Rook both from Stanford and an insightful chapter by PSP Investments’ CIO Eduard van Gelderen and the fund’s chief technology officer David Ouellet among others.

PSP Investments’ is now collecting and reporting on sustainability information based on a technology-enabled, data-driven approach that spans a bespoke, green taxonomy for climate investing to ESG scores derived from AI. (See How Canada’s PSP Investments is getting to grips with climate data).
Clearly forward looking data is important.

“We want to have a better assessment of where things are going,” he says. “Investing is all about the future so we need more analytics to help build a better cone of future scenarios and probabilities. Using these tools, analytics and data will increase the risk / return profile of your portfolio. The future is unpredictable, but these tools can help you to become a better, more resilient sustainable investor.”

The authors first book, Sustainable Investing: A path to a new horizon, was published in September 2020. (See Finance teaching not fit for purpose).