At this Quarterly Investment Forum, we discussed the signals that affirm our optimistic view on the economic outlook and procyclical asset allocation. Our experts also discussed and debated key issues on the investment landscape: active versus passive management in emerging market equities, the opportunities and challenges in crypto, and the boom in special purpose acquisition companies (SPACs).
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The Quarterly Investment Forum (QIF) is an ongoing cross-investment team discussion and debate about the most relevant active risks in major markets and across asset classes and funds.
Each QIF is a mix of 'top down' and 'bottom up' perspectives, beginning with a 'top down' discussion of the major macroeconomic themes identified by the Asset Allocation Team. Each quarter, a rotating roster of portfolio managers present a 'bottom up' view of major active risks in their portfolios.
We have a unique depth and breadth of investment expertise across traditional and alternative asset classes in all regions globally. The QIF leverages that expertise through regular, structured communication between investment teams. The ultimate goal is to improve client outcomes.
1Q 2021 Quarterly Investment Forum highlights
Macroeconomic and market outlook: Room to run
Nicole Goldberger, Portfolio Manager and Head of Growth Multi-Asset Portfolios
Growth is broadening. Powerful fiscal and monetary support coupled with an acceleration in vaccinations is bolstering our conviction in a synchronized global upswing. The passage of additional US fiscal stimulus fortifies our positive view on consumer spending. Income support programs introduced stateside have propelled incomes higher during the COVID-19-induced recession, which is in stark contrast to the environment that prevailed following the Global Financial Crisis. The share of countries in which manufacturing activity is expanding at an increasing rate is near levels reached in 2017. Such strong performance was able to be sustained for a considerable period. We expect a similar narrative to play out this time, with services sector activity also firming meaningfully as economic reopening allows for pent-up demand to be unleashed.
While 2020 was more about beta, we believe this year will be more about alpha in equities, and see greater room to run in relative value procyclical trades. In particular, we favor value relative to growth. Superior expected earnings growth may be an effective catalyst for value outperformance, as the cohort trades at depressed valuations to growth not seen since the dot-com bubble.
We prefer equities to credit, and credit relative to sovereign bonds, expecting further weakness in global duration. Some of our other favored assets include emerging market currencies and Asian credit that trade at inexpensive valuations and benefit from the continued improvement in global activity, as well as the carry available in US high yield compared to Treasuries.
Even after their recent rise, real yields remain at historically depressed levels, and offer support for risky assets. History suggests that equities are able to digest rising rates so long as credit spreads remain resilient. However, when real rates are rising very quickly, this can temporarily challenge the stock market. The recent experience shows that this abrupt rise in yields has been very positive for the value over growth positions in equities. Our optimistic view on risk assets could be challenged on a more protracted basis in the event that China’s credit impulse sharply contracts, or in the event that there is a regime shift to a persistently higher inflation backdrop.
EM: Active or passive?
Benita Mikolajewicz, Senior Equity Investment Analyst, and Boriana Iordanova, Index Research Analyst
The anticipated global economic upswing has increased the appeal of allocating to emerging markets, but the question lingers over whether to use active or passive vehicles to do so. The primary benefit of utilizing an active investment approach is that stocks are not covered as thoroughly by the analyst community as in developed markets. In addition, a substantial share of companies that have tripled in value over the past five years in Asia have limited coverage. This market inefficiency provides opportunities for active managers that engage in deep fundamental analysis. Some difficulties of the active approach in EM is that there are more illiquid stocks, and some vehicles may reach capacity constraints.
In utilizing passive vehicles to enhance emerging market exposure, these liquidity and capacity challenges can be largely overcome, and fees are lower. In addition, innovation in indexing over the past decade allows for a much higher degree of customization than was previously enjoyed. This can help drive excess returns and allow client preferences to continue to shape investment decisions.
Opportunities and limitations in crypto
Stefan Sabo, Multi-Asset Strategist and Michael Bolliger, Chief Investment Officer, Global Emerging Markets at UBS Wealth Management
The important technological development tied to cryptoassets and the blockchain is the ability to store and transfer value without a central counterparty, creating a system resilient to a whole host of shocks, and even censorship up to the nation-state level. The blockchain trilemma involves balancing the trade-offs between security, decentralization, and scalability, and there is currently no one perfect solution that balances all three of these pillars. While Bitcoin commands the most attention in the crypto space, Ethereum is actively focused on upgrading the speed and usefulness of its underlying infrastructure, with many potential benefits including better energy efficiency. Going forward, there are opportunities to bring parts of the conventional financial system onto the blockchain. In addition, some of these cryptoassets like Ethereum may be valued for their income-generating prospects.
These opportunities in crypto, however, must be weighed in relation to the volatility of the assets, high uncertainty surrounding end usage, and potential for enhanced regulatory scrutiny. Bitcoin has not yet proven its worth as a safe haven. Adding it to a portfolio in small amounts has increased the Sharpe ratio, but on a going forward basis it is a bold proposition to assume the magnitude of the price increases will persist or volatility will subside if the business case for this cryptoasset remains muddled.
The rich opportunity set in SPACs
Todd Godfrey and Blake Hiltabrand, UBS O’Connor
There has been a significant maturation of the special purpose acquisition company market in recent years along with an evolving investor base. SPACs have become a more attractive method of going public because of the certainty of execution, certainty of price, speed to market, and ability to discuss forward projections that aid in price discovery.
Exposure to SPACs offers optionality in two forms: the share itself is an option on the sponsor’s ability to create/unlock value, and the warrants attached to the share also retain some value. Sophisticated investors have opportunities to invest in SPACs in many different ways that have varying risk and return profiles, including pre-IPO financing, partnering with sponsors to provide “at risk” capital, and funding through PIPEs.
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