During the current COVID 19 environment, investment in infrastructure should be leveraged as an opportunity to keep people employed, keep businesses afloat and to maintain the productive capacity of the economy.

The current COVID 19 crisis is having far reaching and meaningful impacts on society and the economy.  Deloitte says investment in infrastructure provides one of the key opportunities to keep people employed, businesses afloat and to maintain the productive capacity of the economy.

It explores some key themes:

  • Monetary policy can no longer be effective in stimulating the economy
  • Infrastructure can be used as an effective tool for fiscal stimulus
  • Starting with existing assets allows for “quick wins” and short term stimulus
  • Taking a precinct approach creates wider economic and social benefits
  • Technology can help us deliver infrastructure more efficiently from a time and cost perspective

Read the paper here 

William Blair’s Brian Singer is looking to invest in Europe and emerging markets as the recovery from the global economic shutdown to contain the pandemic will likely take longer than what the market has priced in.

The head of dynamic allocation strategies said the swings in pricing over the next two years would create more investment opportunities outside of the US market, despite a proposed $3 trillion government rescue package. Singer was speaking at Investment Magazine’s Fiduciary Investors Digital Symposium.

“Fiscal policy in the US has probably bolstered the market,” Singer told delegates. “We haven’t seen that in Europe, and Europe is down 30 per cent while the US is down 10 per cent. So the first (investment) opportunity is in Europe, that’s a good place to look.”

Singer was referencing the strong rebound in the US equity market which after plunging by more than 30 per cent from its peak at the end of February, has recouped more than half of its losses. This is despite the surge in the US jobless rate to 14.7 per cent, a level not seen since the Great Depression.

He warned that it could take until 2022 for some global economic growth to return even as governments around the world pledge trillions of dollar’s worth of stimulus measures to support their economies. He also said the “massive reaction” by policymakers would just result in a further misallocation of resources.

“There is so much (capital) that is actually being destroyed with each day that things are not working,” said Singer, in reference to government shutdowns to contain the outbreak. “That suggests to me that this is going to take longer than what the market is pricing in.”

Singer said developed markets were now more debt-laden than the emerging markets, thanks to the massive expansion of central bank balance sheets. He added that while the emerging markets had not yet succumbed to the outbreak to the same degree as seen in the west, it was still a wait and see as to what degree the virus hits the region.

Emerging markets “haven’t been as weak as developed markets through this period, but at the same time the recovery is not going to be coming from such a dislocation,” he said. “So in the equities space, its emerging markets and Europe over the long term (for investment opportunities) though not this week necessarily.”

Singer also likes currencies because central bank policy and inflation around the world “were still investable dynamics on an active basis” and they were generally not correlated to the markets. “It’s probably one of the most valuable things I can see out there,” he said.

On fixed income, the fund manager said that it’s time for investors to prepare for inflation. This is despite interest rates remaining low for an extended period of time at the short end of the curve. On the longer end, he said inflation would start to come through.

As for the return of value, investors will have to wait until central banks stop influencing asset prices which was bound to end sooner or later. “I suspect it will not end well and it will be accompanied by inflation and (an emergence) of relatively slow growth,” the fund manager said.

He also warned that a lot of support for asset prices was not based on fundamentals, which was most evident in the creation of so-called “zombie companies” and in some leveraged buyouts that would eventually decline in price. Singer also cited illiquid assets as another area that investors have piled into, attracted by the misconception that the illiquidity premium on offer was a “free lunch.”

“It’s not,” he said. “An illiquidity premium is compensation for giving up the opportunity to take advantage of other asset mispricings. A lot of people have money locked up in illiquid assets right at the time when things are going to begin to reflect fundamental values. This ethereal vapour pricing that central banks have created over the last decade is not going to last.”

Investment Magazine is the sister publication of Top1000funds.com, both are published by Conexus Financial.

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Professor Stephen Kotkin stops to consider the rollercoaster ride in politics, leadership and policy making that we have seen globally over the past few months. Who will win? What does the future look like? And how will the global economy restructure for survival?

China is winning, American leadership is a deadly shambles.  Then, China’s early failures, lies, and finger pointing have provoked a fierce global backlash, while America’s governors and laboratories inspire hope.  Autocracies are the winners, democracies the losers. However, democracies are using their advantages, and autocracies have flopped.  Singapore showcased its superior governance model; Singapore inflicted upon itself a second wave outbreak (by ignoring its essential migrant labor force).  Jeremy Corbyn and Bernie Sanders flamed out at the ballot box; but the programs Corbyn and Sanders ran on are now being enacted, including modern monetary theory.  Markets are crashing.  Markets are sound and recovering.  Russia won the oil tussle with Saudi Arabia; actually, Riyadh administered a hiding on Moscow; no, everyone lost the oil pique.  The global lockdown shows we can and we must fight climate change.  The global lockdown shows the impossible costs of fighting climate change.  “There can be no return to normal because normal was the problem in the first place,” the graffiti in Hong Kong says.  Worldwide people pine for a return to normalcy.  Globalisation is over.  Globalisation is anything but over.

Whiplash anyone?

Early on in a potentially epoch-defining crisis is not the time to render definitive judgments.

Most experts agree that the coronavirus will precipitate sweeping changes.  They just disagree irreconcilably on what those changes will be.  Sages mostly seem convinced that the world following the pandemic will accelerate in the very direction they have been warning about or advocating for since before the pandemic.

One matter on which there is a deceptive consensus: this is a war.  We will know if our coronavirus responses are an actual war – as opposed to the politicians’ and pundits’ go-to metaphor – if income is decisively redistributed, but in the opposite direction of the past four decades.  Of course, the more consequential issue will be whether we see dramatic moves to address inequality of opportunity.

Historically, we have inflated our way out of these situations.  But business forecasters cannot confidently predict whether the economic consequences are going to be high interest rates and inflation, from a lack of savings and lingering supply chain disruptions against a need to reinvest massively; or low interest rates and deflation, from a glut of savings and cautious consumers amid a quickly reopened economy.  Both are plausible – as is an unforeseen new abnormal.

Back in 1921, the American Frank Knight (1885-1972), a founder of the celebrated Chicago School of Economics and a teacher of multiple Nobel Laureates (Milton Freidman, George Stigler, James Buchanan), published his PhD dissertation on the entrepreneur, Risk, Uncertainty, Profit.  He argued that risk entailed unknown outcomes, but that intelligent bets could be placed based upon probability distributions derived from similar situations in the past.  All investing was a form of applied history.  Uncertainty, however, was different.  It involved not just an unknown but also an unmeasurable possible future.  Knight’s distinction between risk and uncertainty opened up divergent paths to profit.  Uncertainty enabled profits that even perfect competition could not eliminate.  To put the matter another way: risk can be priced well or badly, but there is a form of risk that cannot be priced.

The game of seeing around the blind corner has always been a seductive one.  Otherwise smart people will even pay the players of it.  What is coming?  Food insecurity.  More failed states. An authoritarian wave.  Socialism.  Commodity price shocks.  China’s takeover of the world.  The Asian Century. The unravelling of the EU.  Few players see positive developments around the corner.  Who is going to pay money for good news?

Well, there is good news aplenty.  Trust is now and forever will be the most valuable attribute in business, society, and politics.  Trust takes some time to build, and only moments to squander.  But even when lost it can be recaptured.  And when we can draw upon it, trust delivers.

Democracy is feckless and frustrating, to be sure, and yet dispersed power and authority make possible exceptional initiative and entrepreneurship: the leadership of local officials, the diligence of sceptical journalists, the nimbleness of the private sector, the sense of vocation among professional and service personnel.  Yes, coherence and central coordination are desperately wanting, even in better times, let alone in a catastrophe.  Still, not needing policemen on every corner or censorship of the public sphere is genuine strength.

Finally, what can seem like folly is often the ancient dilemma of the tradeoff.  Just in time efficiency is the greatest cost saving measure of all time, until it becomes crushingly expensive.  Resilience is prohibitively expensive, until it delivers priceless salvation.

Remembering lessons is somehow always harder than forgetting them.  And yet, learning is possible, as we see all around us.  You just have to look.

 

Professor Stephen Kotkin will speak at the Fiduciary Investors Digital Symposium to be held online June 23-24. The event is only open to asset owners.

The Franco-German proposal for a COVID-19 recovery fund is not quite the “Hamiltonian moment” that some have claimed. But, by reshaping the debate on risk mutualization and the benefits of transfers, it could set the stage for one.

LONDON – The €500 billion ($547 billion) COVID-19 recovery fund proposed by German Chancellor Angela Merkel and French President Emmanuel Macron has been hailed as a turning point for the European Union – and for good reason. Beyond its concrete economic implications, the proposal reaffirms a commitment to solidarity by the EU’s two largest economies, thereby setting the stage for genuine progress toward fiscal union.

Click here to read the full article, which featured in Project Syndicate on May 26, 2020.

In recent years in-house, active equity has been the main driver of performance at Norway’s biggest municipal pension fund NK105 billion ($11 billion) Oslo Pensjonsforsikring (OPF) which manages the NK94 billion ($10 billion) DB pension fund for employees of Oslo city council.

The active allocation, characterised by long-term, stable positions, accounts for around 10 per cent of OPF’s assets under management and has just outperformed the MSCI World ESG benchmark index by 2.67 per cent over the last three years. It’s all thanks to a decision made in 2016 to shift the stock picking portfolio from a Nordic to global bias, says Åmund T. Lunde, OPF’s chief executive.

“We had run the stock picking portfolio in-house for a number of years but decided to expand our geographical reach. Mostly because we thought there was something to gain from managing different asset classes internally. It allows us to draw on different views on the market and helps manage the total portfolio,” says Lunde who has overseen the fund since 2009. In its last fourth quarter financial report OPF reported a 10.3 per cent overall return on investments for 2019, up from 2 per cent the year before.

ESG boost

Like many other Norwegian pension funds, the active strategy uses the same exclusion list as Norway’s giant $1 trillion sovereign wealth fund, Government Pension Fund Global (GPFG) based on recommendations from the Council on Ethics, appointed by the Ministry of Finance. OPF also invests according to its own climate policy whereby the 14-member internal team integrate climate risk into all investment decisions.

“We include climate risk scenarios and climate risk investment criteria within our global portfolio, and we also measure the CO2 footprint of that portfolio.” The in-house portfolio is also characterised by its small size. “It doesn’t have a lot of stocks in it,” he says.

Lunde is also convinced that OPF’s returns have benefited from a first mover advantage and experience in climate integration which has become increasingly mainstream through 2019.

“We were integrating climate risk a while ago. What has happened recently around ESG has really helped our portfolio.”

Equity beta comes from an externally managed, global passive allocation (where the same exclusion list applies) that combined with the in-house active portfolio and “a few other mandates” gives equity a 23.5 per cent weight in the portfolio, five per cent more than 2018. “There are two main groups within our total equity portfolio that behave differently,” says Lunde. The fund also has a 3 per cent allocation to hedge funds where the focus is on working with managers over the long term.

Hedging assets

Climate and ESG integration in the internally managed Norwegian fixed income allocation is just as much a priority.

The portfolio accounts for around 30 per cent of hedging assets and includes allocations to money markets, domestic bonds and bonds held to maturity.

The balance between OPF’s risk and return portfolio hasn’t changed in the past three years and Lunde has no plans to alter the risk allocations for now either. Hedging assets account for 57.6 per cent of the portfolio and comprise global fixed income, hedge funds, property and infrastructure. The 42.1 per cent return seeking allocation is in high yield, public and private equity and convertible bonds. The return allocation has increased over the last year due to higher returns from the asset classes rather than fresh money, he says.

As for factors to watch in the coming years, Lunde’s focus is on how best to navigate low interest rates (a notch higher in Norway than the Eurozone) and climate investment.

“These are the two issues we are most concerned about going forward. We are concerned with low rates and how they will impact our returns, and how to protect the portfolio from climate risk.”

Although the externally managed global fixed income allocation has longer maturity holdings, Lunde has kept the duration on the domestic fixed income portfolio “quite short” due to low interest rates and a flat yield curve.

“Shorter maturity domestic bonds mean that we aren’t quite as exposed to the risk of low interest rates [and the risk that they will go higher]” he says. “In fact, we’ve kept a low duration for quite a time now. Over that time we’ve gone from thinking and believing interest rates will go up in the long-term, to just hoping they will.”

That said, he is still confident that economic factors will start to drive rates higher in the next five to 10 years, as opposed, he says, to gloomier peers who predict long term, secular stagnation.

Importantly, OPF does have a key advantage to navigating the impact of low interest rates. It can increase the costs, or pricing, on its pension products to client funds like the City of Oslo when interest rates are low. It involves charging higher insurance premiums to compensate for the loss of income from investments. Contracts are repriced every year depending on interest rate levels, Lunde explains.

“We can mitigate low interest rates by charging our clients an additional price for the guarantees that we offer.”

This joint IMF-World Bank note provides a set of high-level recommendations that can guide national regulatory and supervisory responses to the COVID-19 pandemic and offers an overview of measures taken across jurisdictions to date. The banking sector plays a critical role in mitigating the unprecedented macroeconomic and financial shock caused by the pandemic. Timely, targeted and well-designed regulatory and supervisory actions are essential to maintain the provision of critical financial services, particularly to households and firms that are affected most, while mitigating financial risks, maintaining balance sheet transparency, and preserving longer-term financial policy credibility.

In this context, authorities should employ the embedded flexibility of regulatory, supervisory, and accounting frameworks, and encourage judicious loan restructuring while continuing to uphold minimum prudential standards. Standard-setting bodies have issued guidance to support national authorities in their efforts to provide effective, sound, and well-coordinated policy measures.

Thus far, national policy measures around the world have targeted utilization of available bank capital and liquidity buffers, supporting affected borrowers, promoting balance sheet transparency, and maintaining operational and business continuity of banks as well as payment systems.

However, some developing countries have fewer options at their disposal due to limited policy buffers, weaker implementation capacity, and less-sophisticated regulatory frameworks. This could explain their higher reliance on policy responses that are not consistent with the recommendations discussed in this note, which may generate new risks.

Read the note here.

The regulatory and supervisory implications for the banking sector