Investment themes in focus

Using thematic investing to help you meet your investment challenges

Investors are facing unprecedented challenges in today's global markets. Finding answers can be hard. We have identified a few key investment themes and matched our investment solutions around each, helping you to meet your investment challenges.

 

Toward normalization – the uneven path to growth

Risk assets had a strong start in 2018 until an equity sell-off in early February ended a long period of abnormally low volatility. We see the overall environment as still positive for equities. The gradual journey towards monetary policy normalization continues to be underpinned by broad-based growth across the global economy. In 2017, the demand recoveries in both the Eurozone and in emerging markets gathered pace, while the US economy also strengthened despite rising interest rates. China’s transition from over-leveraged manufacturing hub to a more diversified economy also has progressed more smoothly than many had expected. The breadth of the demand drivers—by geography and by sector—reduces the likelihood of a sharp reversal.

Monetary policy globally is also likely to remain accommodative for at least the first half of 2018 as on-going quantitative easing (QE) programs in Europe and Japan more than offset the slow reversal of QE in the US. And while the Federal Reserve (Fed) is likely to continue raising short-term interest rates, we expect them to do so relatively gradually. Fiscal policy globally is also likely to play a more significant role in supporting demand globally in 2018. We see this backdrop as supportive to global growth and to global equities.

However, while 2017 was largely free of significant adverse shocks in geopolitics, demand or markets, we believe investors must face the reality of an investment journey that is unlikely to be as smooth going forward. We believe that there is further upside to global equities, but also believe returns from equity markets, while positive, may be more constrained than has been the case in recent years. Trade war worries and the erratic nature of US foreign policy are currently weighing on investor sentiment. We believe both the US and China are fundamentally pro trade. Both have left room for negotiation in the recent spat over intellectual property theft. But while we do not ascribe a high probability to a full blown trade war, the risks of major policy mistake have clearly risen.

Additional possible bumps along the road include the potential for higher inflation. We believe that there are structural forces weighing on inflation including ageing populations. However, as output gaps close and as very low unemployment in the developed world starts to squeeze wages higher there is clearly the potential for consumer prices to rise. In China, we believe that authorities have a range of policy tools available to them to smooth the country’s economic transition—but note that there is still the possibility of a sharper-than-expected short-term slowdown as welcome regulatory improvements are imposed on China’s ‘shadow’ banking sector and high debt levels are addressed more forcibly.

Finally, while monetary policy globally remains accommodative, it is on the long road to normalization. As the year progresses it will likely slowly shift to a less accommodative bias. The withdrawal of liquidity and the partial reversal of QE processes globally are likely to be gradual and well communicated to avoid shocking markets—as it has already been in the US. However, since excess liquidity has helped dampen market price swings and support risk assets, it seems only logical that its partial reversal may prompt a shift to a moderately higher market volatility regime.

 

Opportunities in emerging markets

Are emerging markets vulnerable to US and developed world central bank policy, or are they backed by sufficiently powerful secular forces to suggest that the benign environment of the past two years may only be the start of a longer-term positive trend, under- pinned by a positive broad-based and improving global economic upswing?

Perhaps unsurprisingly for an investment universe with high levels of hard currency debt, emerging markets have historically shown a high sensitivity to the US dollar. However, we believe that the peak stress to US dollar strength lies behind us. 2017 surprised on several fronts: stronger and more balanced global growth, positive news from Europe, plus a strengthening euro. This stronger global growth, combined with expectations of very moderately rising interest rates across developed markets (which in turn implies confined debt servicing costs), is supportive to emerging market asset prices.

Until mid-2016, global developed markets experienced low economic growth and persistently low inflation. The ongoing upswing of global growth and moderate reflation are likely to benefit emerging markets which suffered during the years of weak growth. The current brighter growth outlook suggests a preference for investment themes which profit from an economic expansion.

From our perspective, several emerging markets countries are poised to outperform based on their GDP growth. However, country-level GDP growth alone does not always translate into improved investment returns. There are a number of additional factors to consider—for example, the strength of local corporate governance and the impact this may have on performance.

One example of a secular investment theme which specifically benefits many emerging market countries is their growing youthful and tech-savvy populations, whose incomes and propensity to consume are steadily rising. This, combined with a good supply of investible companies from different sectors, creates compelling investment opportunities.

We see consumer spending, healthcare, real estate, and information technology as the key growth themes in emerging markets.

However, the environment is dynamic. It is influenced by various diverging growth trends, and faces many political and economic challenges including industrialization and the digital revolution. We therefore believe that an active country, sector and security selection, based on exhaustive top-down and bottom-up research, is a prerequisite to add value to emerging markets portfolios.

 

Low yield

Low yields have presented a significant challenge to investors for a number of years. With nominal 10-year US Treasury yields not far from 3%, the US economic cycle is clearly more mature than other developed nations, even if yields are well below the average of past recovery peaks. While the positive broad-based global upswing likely to continue, we expect yields to slowly grind higher in Europe (and to lesser extent in Japan) for the foreseeable future.

In our view, there are three paths which could offer potential returns to investors, while endeavoring to avoid assets with low yields and possibly negative returns.

These include:

  • adding to higher yielding bond strategies with floating rate exposure to give protection from rising interest rates and an attractive yield pick-up relative to developed world government bonds
  • within equities, a focus on unconstrained strategies capable of generating returns in differing environments due to more active and flexible investment approaches
  • increasing exposure to alternative asset classes, such as hedge funds, real estate, and infrastructure, which can help to improve the overall risk-adjusted return potential of investors’ portfolios

In summary, the low yield backdrop certainly presents all investors with challenges. But even in this environment, there is still a broad range of investment solutions that mean investors’ experiences do not have to be negative—even if some government bond yields still are.

 

Sustainable and impact investing

Sustainable investing is about broadening the use of material, non-financial data in the investment analysis process to include ESG—or environmental, social and governance—metrics. Incorporating these metrics helps investors take a broader view of the potential upside and downside of their investments and so make better informed investment decisions.

Sustainable investing can provide a new kind of transparency for our investments—achieved through new metrics that offer material, often quantitative, insights into how well a business is run, where its real risks lie, and how sustainable its business model and practices really are. If fully embedded in the investment decision-making process, these metrics can be powerful techniques. This is certainly the case with the ESG criteria mentioned above. Sustainable investing at its best can give investors a forward-looking perspective, providing insights into those qualitative aspects of a business, both good and bad, that further down the line may very well influence the decisions and perceptions of both customers and the public; decisions and perceptions which can ultimately impact that business’ bottom line.

In our view, it is the integration of material sustainability information within our financial analysis and investment process that provide those unique insights into the long-term risks, opportunities and competitive advantages of companies. How do we approach integration? Building on a strong legacy of over twenty years’ sustainable investing experience, our dedicated SI research team works closely with our equity and fixed income analysts to incorporate extra-financial information in analyses and investment decisions. They draw on the most material sustainability data and information and then add their own knowledge of industries and companies to derive a proprietary and forward-looking view of how sustainability impacts financial performance.

Rather than employing sustainability information simply as a screen, based on reported data and historical information, we focus on the future impact that sustainability performance will have on long-term financial performance. It is our belief that this approach results in more holistic and better informed views of how a company will perform over time. In this way, we believe sustainable investing can add value to portfolios within the same risk-return profile.