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Why governments have been focusing on the consumer and what it means for investment opportunities

There are many differences between the 2008 financial crisis and the 2020 COVID-19 induced economic crisis, not the least of which is how the policymakers have responded. In 2008 the bailout of the banks was the focus, and in 2020 the bailout of the consumer was the focus. So why have governments been focusing on the consumer, and what does that mean for investment opportunities? Is this a long-term thematic that investors should be navigating in their investment allocations?

Click below to view Will Nicoll, the chief investment officer of private and alternative assets at M&G Investments, speaking at the Top1000funds.com Fiduciary Investors Symposium global conference.

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Disclosures and important information

_{For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within. This guide reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this guide does not constitute an offer of, or solicitation for, a purchase or sale of any investment product or class of investment products, or to provide discretionary investment management services. These materials are not, and under no circumstances are to be construed as, an advertisement or a public offering of any securities or a solicitation of any offer to buy securities. It has been written for informational and educational purposes only and should not be considered as investment advice, a forecast or guarantee of future results, or as a recommendation of any security, strategy or investment product. Reference in this document to individual companies is included solely for the purpose of illustration and should not be construed as a recommendation to buy or sell the same. Information is derived from proprietary and non-proprietary sources which have not been independently verified for accuracy or completeness. While M&G Investments believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. All forms of investments carry risks. Such investments may not be suitable for everyone. United States: M&G Investment Management Limited is registered as an investment adviser with the Securities and Exchange Commission of the United States of America under US laws, which differ from UK and FCA laws. Canada: upon receipt of these materials, each Canadian recipient will be deemed to have represented to M&G Investment Management Limited, that the investor is a ‘permitted client’ as such term is defined in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. Australia: M&G Investment Management Limited (MAGIM) and M&G Alternatives Investment Management Limited (MAGAIM) have received notification from the Australian Securities & Investments Commission that they can rely on the ASIC Class Order [CO 03/1099] exemption and are therefore permitted to market their investment strategies (including the offering and provision of discretionary investment management services) to wholesale clients in Australia without the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth). MAGIM and MAGAIM are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws. Singapore: For Institutional Investors and Accredited Investors only. In Singapore, this financial promotion is issued by M&G Real Estate Asia Pte. Ltd. (Co. Reg. No. 200610218G) and/or M&G Investments (Singapore) Pte. Ltd. (Co. Reg. No. 201131425R), both regulated by the Monetary Authority of Singapore. Hong Kong: For Professional Investors only. In Hong Kong, this financial promotion is issued by M&G Investments (Hong Kong) Limited. Office: Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong. South Korea: For Qualified Professional Investors. China: on a cross-border basis only. Japan: M&G Investments Japan Co., Ltd., Investment Management Business Operator, Investment Advisory and Agency Business Operator, Type II Financial Instruments Business Operator, Director-General of the Kanto Local Finance Bureau (Kinsho) No. 2942, Membership to Associations: Japan Investment Advisers Association, Type II Financial Instruments Firms Association. This document is provided to you for the purpose of providing information with respect to investment management by Company’s offshore group affiliates and neither provided for the purpose of solicitation of any securities nor intended for such solicitation of any securities. Pursuant to such the registrations above, the Company may: (1) provide agency and intermediary services for clients to enter into a discretionary investment management agreement or investment advisory agreement with any of the Offshore Group Affiliates; (2) directly enter into a discretionary investment management agreement with clients; or (3) solicit clients for investment into offshore collective investment scheme(s) managed by the Offshore Group Affiliate. Please refer to materials separately provided to you for specific risks and any fees relating to the discretionary investment management agreement and the investment into the offshore collective investment scheme(s). The Company will not charge any fees to clients with respect to ‘(1) and ‘(3) above. M&G Investments is a direct subsidiary of M&G plc, a company incorporated in the United Kingdom. M&G plc and its affiliated companies are not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America or Prudential Plc, an international group incorporated in the United Kingdom. This financial promotion is issued by M&G International Investments S.A. in the EU and M&G Investment Management Limited elsewhere (unless otherwise stated). The registered office of M&G International Investments S.A. is 16, boulevard Royal, L-2449, Luxembourg. M&G Investment Management Limited is registered in England and Wales under number 936683, registered office 10 Fenchurch Avenue, London EC3M 5AG. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 3852763 and is not authorised or regulated by the Financial Conduct Authority. M&G Real Estate Limited forms part of the M&G Group of companies.}

The key trends and stand out areas of opportunity in global real estate markets

The year 2020 will go down in history as the year of the pandemic; an epic shock for societies and economies with dramatic ramifications on people’s lives as well as industries. This crisis situation has propelled economies into a new era in which high uncertainty is likely to remain the base case for some time to come. In light of this environment the key trends shaping real estate are examined in this global outlook which identifies stand out areas of opportunity in respective markets globally.

Explore the outlook here

Disclosures and important information

Five years on from a board decision to increase manager diversity, Federal Retirement Thrift Investment Board, the Washington-based defined contribution plan for US federal civilian employees is finally poised to allocate a portion of its giant $640 billion assets to a new manager for the first time.

Since inception in 1986 the fund has only used a single external manager, originally mandating Wells Fargo Nikko Investment Advisors (WFNIA), then Barclays Global Investors and most recently BlackRock to run four key funds.

However, following a consultation back in 2015 that flagged concentration risk, the giant fund pledged to hire another manager to reduce its vulnerability to BlackRock, which manages around $400 billion across the so-called C, S, I and F Funds, suffering a black swan event. Following a series of RFP’s, State Street Global Advisors was mandated to run around 20 per cent of assets across Thrift Savings Plan’s (TSP) four funds starting January 2021.

The funds comprise F Fund (a $38 billion bond index fund that tracks the Bloomberg Barclays U.S. Aggregate Bond Index) the C fund (a $228 billion stock index fund that tracks the S&P 500) the S Fund (a $72 billion stock index fund that tracks the Dow Jones) and the I Fund (a $51 billion stock index fund that tracks the MSCI EAFE (Europe, Australasia, Far East) Index. Around $260 billion is invested in a G fund, an internally managed passive Treasuries allocation.

“BlackRock has always been our only manager, but several years ago our board decided to move to a two-manager structure,” says Kim Weaver, director of external affairs at the fund where the five-strong investment team, headed up by CIO Sean McCaffrey monitor quality assurance and performance and have been working from home since March.

“Should something go awry with BlackRock, State Street will continue to be able to transact business on behalf of our participants,” she says, adding that not only does the appointment of State Street diversify organisational risk providing an alternative, at-the-ready capability to manage funds. But bringing in another manager also boosts competition. However, she confirms that the fund has no plans to boost its manager roster in another push to increase diversity.

“We won’t add more managers going forward. Two will do the trick.”

Federal Retirement Thrift’s startingly simple strategy rests in its defined contribution roots and Congress decreeing from the beginning that investment rests in just five passively managed funds.

“The strategy is born out of simplicity but also a strong belief in passive management,” says Weaver who adds that multiple fund choices and a plethora of investment opportunity often overwhelms beneficiaries, paralysing their ability to make selections.

“DC plans are trending our way now,” she says, adding that the fund engages with investment consultants every five years or so to analyse afresh the benefits of changing the statute to offer different investments.

Not all are DC funds are as simple, however. The UK’s £8 billion National Employment Savings Trust, NEST chose a raft of new managers in 2019 to run illiquid allocations to infrastructure, real estate and corporate loans in a new portfolio targeting 5-10 per cent of assets under management over time. And many Australian defined contribution funds have large allocations to unlisted assets, especially infrastructure.

Federal Retirement Thrift has no such plans, says Weaver. For now, there will be no changes for beneficiaries beyond TSP’s equity and treasury offing.

“We recently looked to supplement the funds we offer but haven’t found any. Everything is structured to manage to the benchmark and there is no ambition to add active managers or do anything differently to what we are currently doing.”

Indeed, plans to do something different were abruptly halted earlier this year. About to realise a board decision first broached in 2017 to shift TSP’s I Fund benchmark to the MSCI ACWI ex-U.S. Investible Market index from the MSCI EAFE index to tap Chinese growth, were scrapped.

Having fought off pressure not to invest in the index which comprises an 8 per cent exposure to Chinese companies the previous November, the fund was forced to bow to the orders of President Trump and dropped the plan. As to whether investing in China is now back on the agenda with a Biden presidency, Weaver says she has no further comment from the May announcement of the about turn.

“We have a good plan, and we are very proud of it and hope it will continue to enhance stability for our participants,” she concludes.

APG’s CIO Peter Branner explains how the pandemic has accelerated key trends already underway around digitisation, central bank policy and action to combat climate change. It all points to fierce competition for private assets.

When APG bought a minority stake in Brussel airport in March 2019 with partners QIC and Swiss Life, the giant Dutch asset manager had no idea that a pandemic was about to ground flights and silence departure lounges. “With hindsight, we could have waited a little longer,” reflected Peter Branner, CIO of the Nertherland’s giant asset manager APG since 2018 when he moved from Sweden to the Netherlands to take the reins of the country’s largest pension provider.

Of course, Branner who was speaking at FIS Digital 2020, believes flying will return and the European hub will soon spark back into life. Just as traffic will return to another of APG’s recently purchased infrastructure assets, a majority stake in Portuguese toll road Brisa, bought with Korean and Swiss investment partners in 2020. “We have to prolong our growth expectations for GDP in Portugal somewhat,” he says, in reference to the fall off in revenue.

“But people will still drive, maybe not the same cars, but they will drive.”

It leads him to reflect on how climate will become a new focal point in the post-COVID world and how other trends, accelerated by the pandemic, might impact APG’s €459bn portfolio manged on behalf of seven pension funds representing a combined 4.6 million people – in a population of 17 million.

“Many of the trends we saw in the Spring before the pandemic broke out are still there and reinforced,” he says. “It has made my job easier to some extent because we’ve seen the trend; we just need to move faster. It is interesting to see how central banks were important before and are now more so. Digitization has speeded up and China seems to be stronger still. If you look at GDP growth, China is the only region with positive growth.”

APG is already a renowned investor in climate opportunities, but with the pace of investment set to step up, Branner lists opportunities in electrification and the Grid, and wind energy in France and Portugal where APG’s focus will be on buying private assets with other investors.

“This is the most important area of our private portfolio,” he says.

That said, he is mindful about strong price moves, accentuated by the pandemic and general hype around infrastructure assets .

“We can see how infrastructure investments are getting more hype. Its where we’ve seen the strongest price moves and these trends are reinforced by the pandemic.”

It’s a fierce competition that is bound to spike once the pipeline opens up and private asset investors can carry out the due diligence and deep dive analysis that is impossible without travel. “We normally travel to see the factories and highways we invest in. We need to come back to this. I am worried about the pipeline.”

Other trends he believes are here to stay include working from home. Indicative in the fact the asset manager has hired 62 people through the pandemic, all working from home and on a new geographical level playing field whether in the asset manager’s offices in the Netherlands, New York or Hong Kong.

“It is encouraging to see how the workforce is coping with this so well.”

Going forward he says only 60 per cent of APG’s work force will come back to the office “in a permanent shift downwards.”

However, although he believes new trends will shape demand for office space, he doesn’t believe this trend will necessarily see city centres empty out.

“City centres are still expensive versus the outskirts; city centres are always attractive – I don’t expect that to change too much.”

Canadian pension fund OTPP’s chief economist forecasts tough times ahead: COVID spending has papered of the cracks of existing problems; it yields nothing but there are few alternatives to fixed income and inflation is on the way.

There is no easy silver bullet for frustrated investors looking for an alternative to rock bottom developed market fixed income yields, said Millan Mulraine, chief economist at C$204.7 billion Ontario Teachers’ Pension Plan. The list of alternative allocations currently touted spans gold or more exotic assets like Chinese government bonds, yet few provide the same leverage, liquidity or depth for portfolios as US and developed market fixed income. They should only be viewed as a bridge until developed market yields recover on inflation and growth, and the ensuing easing of financial repression.

The challenge is compounded because yields are likely to stay low for a while yet, said Mulraine who joined OTPP in 2016 to lead the economics team, tasked with macro-oriented research to inform the fund’s investment decisions. Central banks are close to spent on the fiscal and monetary ammunition needed to spur growth, having bought forward future growth to navigate the pandemic with government leverage and lower rates. “2021 is shaping up to be a good year for markets, but I cast a wary eye beyond 2021,” he said.

Moreover, challenges wrought by the pandemic have come on top of existing problems. “Not much has changed from the pre-COVID trajectory that we were on. We have just papered over the cracks and are dealing with problems with less fiscal and monetary room.” Listing below-trend growth, crimped global productive capacity and lower yields impacting returns, he said shaping a portfolio at OTPP, which has earned an annual total-fund net return of 9.5% since it was founded in 1990, has just become infinitely more complex.

According to OTPP’s most recent annual report (2018) fixed income accounts for 41 per cent of the asset mix. Of that, 37 per cent is in Canadian government bonds, 27 per cent in foreign developed market and sovereign bonds, 25% in real-rate products and 11 per cent in provincial bonds. Elsewhere public and private equity account for 35 per cent or AUM, inflation-sensitive assets 15 per cent, and real assets 26 per cent. The remainder is in credit, absolute return strategies and money market funds.

Mulraine’s wary eye on inflation is also keenly informing OTPP’s direction. Inflation has been in a “sweet spot,” laid low for two decades thanks to accommodative central bank policy providing a boost for asset returns. Although Mulraine doesn’t believe prices will spike in the short-term, he does warn that a shock could be in the offing. “The inflation outlook is more uncertain now than it has been over the past two or three decades. I wouldn’t be surprised if two to three years down the road we have an entirely different inflation regime where inflation is surprising to the upside,” he said.

OTPP is preparing the portfolio by ensuring diversification across geographies and making sure natural hedges are in place. Allocations to real assets where valuations rise in line with inflation are also a vital cushion and insulation as bonds take a hit.

“If inflation goes up, we know real yields will continue to be depressed. This is one approach we should consider when navigating the environment for the next five years.”

Indeed, it is in times like this that OTPP’s high allocation to private assets comes centre stage.

“It is no secret this is one of our sources; it is likely to be more of the same,” he said. Here, success depends on geographic diversification, and he notes an increasing emphasis of exploring assets outside North America. “We think in a more meaningful way how we do this allocation. North America has paid back handsomely, but this may not be the case going forward,” he says, pointing to new pockets of strength around the globe in other markets.

For example, OTPP has around $15 billion invested in APAC across public equity, private equity and infrastructure, and recently opened a new Singapore office to accelerate its ambitions for the region.

Meanwhile, OTPPs celebrated internal management (around 80 per cent of AUM is managed in-house) is a vital component to alpha generation in private assets across real estate, private equity and infrastructure.

“You can ride over the vicissitudes of the global business cycle with private assets; there is that smoothness you can get to your return. When you sell that asset, you can benefit from upside. It’s an important part of our portfolio and revenue generation. We have pensions to pay, we can’t just play in public markets and when things aren’t going our way, sit in our hands.”

USS’s head of dynamic asset allocation Bruno Serfaty reflects on the inflation risk coming down the track, and suggests ways investors can build alternative liability matching portfolios beyond government bonds.

In recent years, inflation has boosted asset prices and asset owners have benefited disproportionately compared to economic activity. The dark side of inflation however, when wages and costs spike to hit corporate profitability, could be edging closer. Speaking at FIS Digital 2020, Bruno Serfaty, head of dynamic asset allocation at USS Investment Management, the in-house manager for the £68 billion Universities Superannuation Scheme, the United Kingdom’s largest pension fund, warned investors that inflationary dark clouds could soon appear on the horizon.

The shift towards greater state involvement in the economy could lead to higher inflation over the longer-term, while fiscal policy might shift to higher spending and taxing, with a more redistributive tilt to reduce income inequalities. “This may impact, at some point, the profitability of companies,” he said. Elsewhere, he flagged that tariffs on goods courtesy of the China/US trade war and Brexit will also cause prices to rise. “We could be at this cusp where we have moved from the good side of inflation where every asset went up to more of the dark side, and we as asset owners need to be prepared for this.”

Cue recent strategy at the fund like its 2020 £400m investment for a 49 per cent stake in a fuel station portfolio owned by oil major BP.

The annual rent reviews are linked to inflation, providing the scheme with liability-matching cashflows in an investment that will sit in an existing property portfolio of nearly £4 billion and is part of USS’s £18 billion allocation to private markets. Elsewhere, the pension fund has a 6.5 per cent exposure to nominal government bonds and a 26.9 per cent allocation to linkers, increased during the Covid shock to take advantage of the market’s fear of deflation. The fund also believes pricing remains attractive due to lack of inflation hedging demand amongst pension funds.

When the conversation turned to the enduring challenge of rock bottom fixed income yields, Serfaty suggested asset owners reassess why they hold bonds in their portfolio. A similar process has helped inform USS’s construction of a liability matching portfolio based on real assets in private markets and the credit space.

The deconstruction process helps clarify the rationale for holding fixed income. Whether that is based on a belief that bonds are an important source of diversification from growth assets; a belief that inflation will stay low and bonds provide good real returns or if bonds are a store of value because they are the safest instrument, and where money is best saved. “If you decompose the reasons why you own bonds, then you can try and find alternatives to that,” he said.

For example, volatility products or credit opportunities could provide alternatives to bonds as a hedge against an equity drawn down. While asking if bonds really do provide the best store of value has to be seen against the backdrop of vast government issuance. “If governments are printing so much money, I do wonder if they are truly a good hedge. Maybe gold or currency diversification could help – these are different avenues we look at.” Here USS recently took steps to improve the diversification of its foreign exchange exposure and increased allocations to currencies with defensive properties during turbulent times such as the Japanese yen.

It leads him to reflect on the long-term impact of the policy response on the portfolio. Government borrowing, coming on top of already high levels of government debt before COVID, will impact asset prices for many years. Expect a highly liquid environment and stoked competition for real assets, he concluded.

“What is really unprecedented is the scale of the policy response that has taken place. We started with a high level of debt before COVID and we are getting to an unprecedented level post COVID. GDP in 2021/22 is going to bounce, but what is not going to bounce is the level of debt – in fact it is quite the opposite. This year in the US for example, debt is 15 per cent of GDP: that’s a large number.”