“We didn’t have any sleepless nights,” Jenny Johnson, president and chief executive of Franklin Templeton told FIS 2020 Digital delegates, reflecting on one of the largest purchases in asset management history on the eve of the pandemic in February.

“We are long-term, and the reasons we did the acquisition still remain today.”

Franklin Templeton’s cash purchase of rival Legg Mason was driven by the need to fill product gaps and move more into the alternatives space, as well as diversify the active manager’s client base, she said. Now the focus will be on investing in AI, data and fintech across asset classes which account for a combined $1.5 trillion.

“We still have lots of cash to invest in the business,” she said.

The merger will help the two firms navigate trends in the asset management industry including downward pressure on fees and more customisation, said Johnson.

She said institutional partners increasingly seek thought leadership, and that active managers like Franklin Templeton are increasingly responding to institutional client demand for data analytics.

For example, the firm’s global macro team has built an ESG data platform bringing together ESG data feeds from 17 different sources to support investment research, she said. Active managers will be able to take advantage of the market dislocation caused by COVID-19, Johnson continued, although she flagged that government intervention has reduced the level of dislocation, making it “more difficult” in the short-run.

She also said that the asset management industry will have to adapt to employees working from home. A new flexibility will see firms support employees who want to work from home and that employees may only come together “some days of the week”.

Elsewhere, she noted how distribution and sales teams will travel less because of digital communication. Active managers have always worried how often their portfolio managers visit clients because it takes away from research, she said. Now, COVID-19 will result in less travel and more efficiency. She also said that ESG investment would see more of a focus on the integrations of social factors.

Reflecting on growing racial tension in the US and the recent high profile firing of a senior Franklin Templeton employee for racism, Johnson said “she’d learnt a lot in the last couple of weeks”. She said that equality is not only the right approach but diversity is proven to produce better outcomes. She also said that it was “a good thing” firms and individuals are increasingly accountable for their behaviour.

However, asset managers need to do more, particularly in boosting diversity and inclusion in the underlying companies they own. She said most black-run businesses and female entrepreneurs struggle to attract venture capital, and that the industry needed to do more to ensure capital is available to these groups. Everyone has a fiduciary responsibility to make sure they are getting returns, but she urged investors to “change the lens” on how they view investments to enable capital to flow to these groups.

Johnson also reflected on a new purpose in asset management.

“What we do every day really matters,” she said, referencing the in-depth research carried out by Franklin Templeton’s biotech team into companies developing a COVID-19 vaccine. She said although Wall Street is viewed as “greedy,” people working in asset management do care. She also urged a keen focus on helping pension funds that are underfunded.

“For us it is just staying focused on what is important,” she concluded.

Current fiscal and monetary policies are taking the world down a necessary, but dangerous path, according to co-CIO of Bridgewater Greg Jensen. He told investors asset allocations should focus on diversification, and assets that benefit from fiscal and monetary policy moving together.

COVID-19 will radically accelerate trends that were already underway, said Greg Jensen, co-CIO Bridgewater speaking at FIS 2020 Digital.

In a wide-ranging speech to delegates, Jensen said the trend in growing corporate profits was now “close to an end,” and that company profits would now grow in line with economies. Elsewhere, the massive “increase in debt relative to income” that has grown in recent years faces the reality of “promises being met.” He also flagged the dominant role of central bank policy, and new unknowns around the US dollar as a stable reserve currency and inflation.

Corporate power

Jensen told delegates that COVID-19 had dealt corporates “a big hit.”

The damage they have suffered will become apparent via holes in their balance sheet, despite the policy response. Over the past 40 years corporates have benefited from globalisation, de-regulation and a weakened labour force, however these trends are also coming to an end.

“We are getting closer to the end of a long trend in growing corporate power,” he said.

Jensen said that unsustainable trends around worker conditions are unlikely to continue because democracy will “push back” on unchecked capitalism. The ability for companies to “shop” for tax rates around the world or exploit labour via tapping the global labour pool, are coming to an end. “We are already seeing companies recognise that if they don’t move in this direction, they will be forced to,” he said. “If companies don’t act pre-emptively, it will happen to them.”

The trend to ever lower interest rates is also coming due, said Jensen. Low interest rates have caused debt to surge, leaving IOUs at “ten times income.” Jensen explained how in the wake of the GFC low interest rates have been followed by quantitative easing (QE). He said that QE is not as effective as interest rate policy and “reaches its limit” when it pulls the risk premium out of assets and money flows “back and forth” between cash and bonds.

Today, in a new phase, coordinated fiscal and monetary action has seen money go “out of the door” where it is spent in the real economy with possible inflationary consequences. Today’s challenges also come against the backdrop of a shifting political system as populism rises around the world and rules around regulation and tax change, he said.

Casting back over centuries, Jensen charted the rise and fall of empires. Back in the 1500s, China was the strongest power in world but then declined, usurped by the Dutch, the British and then the US – now declining against a surging China. He also referenced the different types of power empires hold from educational, military, and financial.

“Financial power peaks at the end of an empire, it’s the last thing to go,” he said referencing the dollar’s reserve currency status.

In this fast-changing world, returns on assets will be low, said Jensen. He warned that diversification is more important than ever, but also more difficult given that nominal bonds no longer play a diversifying role. He urged investors to understand the levers of monetary policy and how this will drive markets. Bonds used to be a defensive asset because bond prices would typically rise when central banks cut interest rates to try and bolster a struggling economy. He said now investors need to find new sources of diversification.

Jensen noted that a great deal of money has been “squeezed” into equities driving prices up, yet measuring the appropriate p/e ratio of a stock is difficult when interest rates are zero.

“We are seeing significantly higher p/e ratios than we used to,” he said. He said asset allocations will focus on diversification, and assets that benefit from fiscal and monetary policy moving together. In contrast, de-globalisation will mean that assets no longer move up and down as they did across the global economy, and that investors need instead to navigate new supply chains and “a more independent” Chinese currency.

Jensen concluded that current fiscal and monetary policies are taking the world down a necessary, but dangerous path. High debt levels that people can no longer pay out of income fuels populism. He said we could emerge from the crisis with lower debt levels and avoid inflation, however this required central banks to not lag in their response. In a final warning he said that markets today are priced to reflect policy makers “getting what they want” in an alignment that may not always be the case should inflation, inequality or delayed re-opening come to the fore.

Central banks are trying to change asset prices via massive interventions, Randy Kroszner, Deputy Dean for Executive Programs and Norman R. Bobins Professor of Economics at the University of Chicago Booth School of Business told FIS 2020 delegates. In the opening panel that set out the consequences of the policy response to COVID-19, he explained that central banks actively sought to raise asset prices when markets crashed and ceased functioning in the wake of the pandemic. “It [the policy] bought things back up as planned,” he said.

Now, however, central bank’s power may be limited. The Federal Reserve cannot repair supply chains, cure the virus, or persuade people worried of catching it to venture out Kroszner, who was a former governor of the Federal Reserve, said.

That said, central bank support of asset prices has allowed companies to build up their balance sheets. The rush of corporate debt and equity issuance since February is a consequence of firms wishing to hold cash in uncertain times, creating what Kroszner called “fortress balance sheets.” It means that should another crash come, companies are well prepared. As long as companies have cash on hand, they can weather a tough recession, he said.

European opportunity

The crisis has provided a unifying opportunity for Europe, said Lucrezia Reichlin, Professor at London Business School and founder of Now-Casting Economics. She told delegates that Europe’s monetary and fiscal policy response has differed from 2008. She said the purchase of assets by the European Central Bank, where she used to be head of research, revealed a new level of flexibility to support weaker European economies like Italy, relaxing proportionality rules.

“This flexibility has been adopted by all members of the Governing Council,” she said. Elsewhere, she noted innovation around guaranteeing market liquidity.

Regarding fiscal policy she said governments had more room to move to put fiscal packages in place to provide liquidity to households and companies.

She also noted another “new phase” emerging in the shape of the EU recovery fund, with funds raised used to support EU spending. Reichlin told delegates that the ECB has to tread a fine line between coordination and independence. Central banks now have a broader set of tools and a larger role in the market, she said.

Recovery plan

Kroszner said that the Federal Reserve and other central banks will have to act quickly on withdrawing stimulus if “markets are right” and a recovery is on the way.

Although he noted it will take a while to get back to where markets were before the pandemic, he said central banks will have to time withdrawing their support to avoid inflation.

“They should be able to do it. Programs are easily and quickly reversible but there is downside risk,” he said. “It may be challenging for central banks’ to pull back quickly enough.”

He added that although the Federal Reserve is forced to consider negative interest rates, it would try to avoid them.

Reichlin told delegates that she didn’t see inflation coming, although she warned it can come suddenly and that central banks should be prepared.

She said the bigger challenge was deflation, but that policy makers have the tools to keep interest rates and inflation at the right levels.

“Central banks will have the capability of acting in a timely way, but we shouldn’t be complacent,” she said, urging policy makers to use all tools to sustain the economy both in terms of market infrastructure and aggregate demand. Going forward, innovative coordination between fiscal and monetary policy will be key, she said.

Kroszner agreed that low inflation is more likely in the short and medium term since people will have less purchasing power. He said policy makers’ priority is to ensure markets continue to function, and that the better markets functioned, the easier it would be for firms to build up their balance sheets.

The second day of the Fiduciary Investors Symposium Digital 2020 will take place on June 24 starting at 2.00pm BST. To join the conversation register at www.fiduciaryinvestors.com

The speed and force of the policy response to the financial shock unleashed by COVID-19 has been unprecedented and welcome, however the world needs a more effective strategy in response to treating the virus itself, said Larry Summers, President Emeritus, Harvard University.

Speaking at FIS 2020 Digital the senior US Treasury Secretary for the Clinton administration, and former director of the National Economic Council for President Obama told delegates that if people don’t feel safe “going to the shops” the economic recovery will be limited no matter where interest rates are or the amount governments spend.

Summers told delegates he was “disappointed” at the absence of more pervasive testing, contact tracing and coordinated efforts to distribute a vaccine when it comes ready. He also called for more action on developing future capacity for the next pandemic, warning “this won’t be the last one.”

US woes

Reflecting on how the US is weathering the storm he said the most recent retail sales and employment figures had been better than expected. However, he said there was a high risk of a ‘W’ shaped recession where the economy rises but then falls back, or a ‘K’ shaped recovery where the rich keep getting richer, and the poor, poorer. He also flagged other risks whereby the virus gets out of control again, and people stop spending.

However, Summers said that perhaps the most “profound question” rests with the successful functioning of US democracy and America’s continued ability to “lead the world” and cooperate with other nations. He noted that the pandemic has come against the backdrop of existing challenges from crumbling infrastructure to declining life expectancy, racial injustice, inequality (particularly in health and education) and an unwillingness to support global institutions.

“Society isn’t working,” he said, adding that the US’s “polarised and ineffective” society is now on show to many countries who look to the US as an example – something he referred to as “an immense challenge.”

Summers said that whatever delegates’ view on the role of government versus the private sector, any bigger role for the US government demands a confidence and trust that is lacking in the country today. He also said that he finds it “hard to believe” that the size of the US deficit doesn’t matter.

“The amount I can spend is related to the present value of my income. Budget deficits matter and any suggestion they don’t is misguided.”

However, he flagged that viewing the budget deficit in terms of something to be “controlled” wasn’t helpful, and said the size of the budget deficit should be seen in the context of multiple factors, including low borrowing costs. Moreover, equally concerning as the budget deficit is the educational deficit, potholed roads, and the country’s lack of readiness for the climate crisis.

“I don’t subscribe to the orthodoxy that excessive borrowing is so damaging,” he said.

Reflecting on how long the current fall in output would last, Summers said that on one hand today’s challenges were deeper than after the GFC, suggesting aftershocks ahead. However, he also noted that there will be enduring productivity increases because of the technological changes COVID-19 has hastened, and our ability to be more efficient. He noted that prior to the GFC, productivity was already slowing so that the subsequent decline in output wasn’t wholly linked to the recession that followed. There will be some hysteresis, but it will be less apparent than previous times, he said.

Inflation

Summers warned delegates that it would be “a mistake” to view a substantial increase in inflation as “inconceivable,” arguing inflation’s reappearance is now more likely than he thought six months ago.

“Things have a way of coming back,” he said. However, he also noted deflationary pressure, including workers fearful of losing their jobs spending less.

Elsewhere, the conversation turned to the opportunity universities face from the current disruption. He said now was the time for universities to spread their influence and magnify their impact all over the world, creating more engaging video content and increasing personal contact with students.

“Will it take place?” he questioned. “I don’t know.”

As for America’s ability to adapt to the challenges it faces, he said American society had proved its resilience many times in the past. People predict doom, and as they do so they set in motion changes that lead that doom not to happen, he said. “I hope our best days lie in the future.”

Summers noted that if China raises living standards in line with Taiwan, it could soon have an economy twice as large as the US. However, he noted that these types of “power transition” are not easy.

He urged for much greater cooperation between the US and China, likening the two powers to a couple in a boat, adrift on a turbulent sea and far from the shore. Both need to accommodate each other through mutual respect on areas of great importance to find a way to safety, he urged.

As for the likely outcome of November’s Presidential election, Summers argued there are three possible scenarios, each with the same chance of happening: Trump wins in a “continuity of chaos;” Biden wins, or Biden wins with “a very substantial margin” that sets the US on a new course.

In a final thought, he urged investors to cluster around infrastructure and investment that helps solve inequality, concluding that investors that integrated ESG early will benefit. Not only from the “good things” happening to such companies, but also from future investor demand.

For some investors, plunging equity valuations in March were an opportunity to ‘get back in’ at reasonable prices. More recently the rapid recovery has been a cause to position conservatively once again. Asset allocations and the correct exposure in today’s challenging markets is a pervasive theme at FIS 2020, where panellists will also discuss how shifting corporate supply chains will impact investor strategies.

Veteran contrarian investor Matt Clark, CIO of the South Dakota Investment Council (SDIC), argues that for now, at least, the chance to take advantage of price dislocations by increasing exposures has passed. The rebound in equity markets has led the internal team to position the fund conservatively once again he explains, reflecting on how the crisis is impacting the $15 billion fund’s asset allocation, another central theme at FIS 2020.

Strategy at the pension fund for the US state’s public-sector employees is focused around adjusting asset allocation exposures as prices fluctuate around the team’s assessment of fair value. Rapidly changing events in February and March “stepped up the pace,” explains Clark.

“The crisis has definitely stirred up relative valuations providing opportunities to reposition whenever relative prices shifted more than our analysis suggested was justified,” he explains.

Indeed, the March decline provided an opportunity to get back into the market at reasonable prices. “We are a long-term focused, contrarian-leaning investor. Our valuation work suggested that markets were significantly overvalued at the end of 2019, so we were conservatively positioned. In March, markets become moderately undervalued allowing some overweight exposure.”

However, things have since changed given the swift and rapid recovery, he says.

“The recovery, in our view, has taken valuations back up almost to the levels in January, particularly when a modest amount of longer lasting earnings impairment is taken into account. As a result, we have in recent days shifted back down to our earlier, very conservative position.”

Supply chain risk

How companies’ navigate the pandemic’s consequences on their supply chains will be a key influence on market behaviour. China’s shut down hit western factories dependent on Chinese components in a disruption that could now accelerate attempts by companies to diversify away from China. Elsewhere, the pandemic is turning countries inward and the demand for self-sufficiency is rising – most prevalent in health-related products.

“In my opinion, de-globalisation will impact portfolios via decreased profits for certain platform companies that will be less able to have their products manufactured in cheap labour countries – think Apple for example,” says Olivier Rousseau, executive director of France’s Fonds de reserve pour les retraites “If de-globalisation is in fact mostly ‘de-Chinaisation’ then the impact could be less because other Asian economies (Vietnam, Indonesia, Malaysia, Thailand) will replace China as on offshoring Eldorado. In the short term there would be increased costs caused by the transfer of physical supply chains.”

Rousseau also believes the COVID-19 crisis has shown companies the importance of maintaining reasonable levels of inventory.

“In the pharma sector it is probable that governments will be much more interventionist and demand that big pharma re-onshore a lot of their production and keep large inventories of critical imported inputs. At the same there will be more public and private money available for biotech,” he predicts.

FIS2020 will discuss other trends in equity markets too. Passive investors may have to consider if buying the index as a whole still makes sense if some industries will be safer investments than others: travel is unlikely to rebound soon; banks could face increased risk as corporate insolvencies rise. Even within seemingly robust sectors such as technology, there will be divergence by company. Amazon is hiring, Microsoft says the numbers using its technology for remote conferencing has boomed, but Apple chief executive Tim Cook said the company is in “the most challenging environment” it has ever seen speaking at a recent conference call to discuss the company’s results.

The Fiduciary Investors Symposium Digital 2020 on June 23 and 24 will look at the extreme uncertainty of the global economy including the changing geopolitical dynamics and the potential unravelling of globalisation; the unprecedented fiscal and monetary policy responses and the implications for investments; how investors are positioning portfolios and managing short and long term risks; supply chain risks and responsible capitalism; what a sustainable recovery looks like and how investors can ensure it happens.

Asset owners can register for the Fiduciary Investors Symposium here.

FIS 2020: The policy response

FIS 2020 will discuss how the unprecedented government stimulus in response to the pandemic could affect investor returns and specific allocations. Areas of concern include a sharp rise in zombie companies kept afloat by government support. Elsewhere, delegates will discuss how changing work and retail habits will impact real estate.

Investors don’t know what the future will look like. Instead, asset owners should focus on what it could look like and prepare for a range of possibilities, says Geoffrey Rubin, senior managing director and chief investment strategist at Canada’s $420 billion CPP Investment Board. He says the impact of the extraordinary monetary and fiscal intervention of recent months is front of mind.

“It’s the first thing we need to grapple with,” says Rubin, who will also speak at FIS 2020 next week. Its implications will reverberate across different time horizons with short-term relief likely to give way to substantial, longer-term challenges, he says.

Opportunity in the policy response

One area of opportunity in the policy response is the fresh momentum it has given the energy transition. For example, Germany’s €130 billion stimulus package, which Chancellor Merkel described earlier this month as “charting Germany’s course for the future” prioritises the green economy visible, for example, in a huge expansion of electric car charging infrastructure.

“We are sure that these matters are going to be extremely relevant in our mandate decisions,” says Ignacio Javier Hernández Valiñani, who heads up Spain’s largest corporate pension fund, the €5.8 billion ($6.5 billion) pension fund for CaixaBank employees. “The change is going to be faster than we originally thought.”

The fund’s recent decision to introduce ESG indexes in its benchmark have stood it in good stead during the crisis, he adds. “These ESG references behaved much better in this market than traditional versions. We think there is a big path ahead for sustainability, and will continue our focus on that subject.”

Risks

Another area the stimulus will have profound implications is distressed debt. Here FIS delegates will hear from Victor Khosla, founder, VSP Global on the perils and opportunities that lie ahead in an asset class where investors, starved of yield from safer government bonds, have increased their allocations in recent years.

Similarly encouraged by low rates, many riskier companies have gorged on cheap debt for the last decade. Now they’ve also tapped unprecedented government support, yet this won’t address the fact many face insolvency as their debts overwhelm collapsing revenues. Vulnerable sectors include travel or those facing disrupted supply chains, areas where rating agencies are sounding the alarm. As Paloma San Valentin, managing director for the Americas at Moody’s flagged, there is now a “growing risk to corporate credit quality around the world.” As for opportunities, they lie with well-capitalised lenders with a long-term focus and companies with strong balance sheets.

Real estate

Another asset class facing huge change is real estate as the pandemic accelerates trends in how we work, live and shop. FIS 2020 will hear from Jon Cheigh, CIO at Cohen & Steers on how to best combine listed and unlisted real estate opportunities and balance liquidity in the years ahead.

“Demand for shopping mall space will reduce and demand for logistics space will increase probably, but what if we find a very satisfactory cure to the virus?” asks Olivier Rousseau, executive director of Fonds de reserve pour les retraites, France’s €32.7 billion pension reserve fund, who is also on the program. “A sure bet is that demand for super-fast internet connectivity will increase faster than we could expect.”

Elsewhere, challenges in real estate have made some investors wary.

“Today’s situation may increase the choice available in this kind of asset, but we want to be sure that investment doesn’t increase our risk profile. Given its illiquid nature, we don’t want to rush in just because the pandemic has temporarily increased the number of good opportunities,” says Spain’s Hernández Valiñani.

FIS 2020’s unpicking of the policy response will cover other key considerations too. Delegates will hear how the response could herald a shift to EU fiscal union. Germany and France have joined forces to push for an EU recovery fund, so that money raised by the European Commission borrowing from the capital markets goes to support EU spending, rather than the more typical loans to national governments.

Elsewhere, experts will discuss the implications of China spending much less on its rescue than others. According to the IMF’s fiscal tracker, China’s COVID-19 support packages (including spending, loans and guarantees) amounted to only 2.5 per cent of its GDP by April, compared to 34 per cent for Germany, 20.5 per cent for Japan and 11.1 per cent for the US.

Asset owners can register for the Fiduciary Investors Symposium here.