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

The gradual journey towards monetary policy normalization continues to be underpinned by a broad-based improvement in the global economy. The US economy is further advanced along this path than its European and Japanese counterparts and as a consequence, the Federal Reserve (Fed) is likely to continue raising short-term interest rates in 2018. However, due to ongoing quantitative easing (QE) programs in Europe and Japan, central bank liquidity globally continues to expand and monetary policy in aggregate is likely to remain accommodative.

Compared to other central banks the Fed has made the greatest progress in scaling back the ultra-expansive monetary policy which prevailed for close to a decade. It tapered its bond purchasing programs in 2014 and 2015 and raised the federal funds rate in five steps to a target range of 1.25 -1.5 percent. The European Central Bank plans to maintain its bond purchases at a pace of EUR 30bn a month through September 2018. The decision to end all purchases will depend on whether Eurozone inflation reaches its target of close to 2%. Hiking rates will only be considered after the termination of the bond purchasing program.

When the Fed started QE in response to the global financial crisis after 2008, many investors saw the risk of even greater financial instability down the road. They saw this monetary stimulus as an ill-advised policy which would produce a 'sugar rush' in economic activity and asset prices that would morph into a disaster once the artificial stimulus was withdrawn or even just reduced.

While QE is much better understood today than when it launched, we don't think that all negative side effects can be avoided. It's premature to assess the scale of possible asset bubbles, and the riskiest parts of the market might be where investors have been lured into an overestimation of future returns and an underestimation of the associated risks. The long lasting tailwind of still increasing liquidity at the global level might have seduced some investors to own a portfolio with a risk profile in excess of the one they can and should afford. A desired de-risking of these portfolios might exacerbate technical pressure in correcting markets.

Some pockets of instability might not survive an ordinary unwinding of the stimulus, and in case of peripheral European government bonds an underestimation of the fiscal challenges of some countries might have occurred. The scale of ECB purchases relative to the size of these markets has been so huge that current prices hardly reflect an unbiased assessment of government debt's attractiveness. Effectively as yields continued to fall investors have been even rewarded to become complacent, overconfident and ignoring risks. Anticipating the end of the ECB bond buying program scheduled to run through September 2018 yields might edge up and find their new equilibrium at higher levels..

The Fed’s policy experimentation might be instructive for other countries that followed with lags on the same route. Japan engaged in full-scale monetary stimulus in 2013, five years after the Fed with Europe following suit. The fact that in many emerging economies monetary stimulus and economic recovery picked-up later implies that business cycles and monetary policies are not as synchronized and thus as vulnerable as in past expansion cycles. The drivers of global growth are more broad based geographically and by sector than has been the case in many previous cycles.

That is good news for investors. While the Fed is raising interest rates, Europe will not do so before the end of 2018 and Japan is set to remain accommodative for longer.
However, after a year that was largely free of significant adverse shocks in geopolitics, demand or markets, we believe investors must prepare for the likelihood that their investment journey is unlikely to be as smooth going forward as it has been over the past year. We believe that there is further upside to global equities, but also believe returns from equity markets are likely to be lower than has been the case in recent years.
Against this backdrop, after a protracted period during which beta (the market) has dominated returns, we see a shift toward portfolio manager skills (alpha) playing a much greater role in generating returns. As rates go up, the pace of appreciation of equity markets slows and it is realistic to expect that over a 5- to 10-year period returns will be lower than those experienced over the past few years.
In this phase of the cycle, every 50 basis points of alpha will be worth its weight in gold and the appetite for alpha-oriented strategies is likely to grow.


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 one and a half years may only be the start of a longer-term positive trend, underpinned 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 has 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 low interest rates across developed markets (which in turn implies lower 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. We see a moderate US-led normalization which is slow and expect inflation and interest rates to reach levels well below the average of past recovery peaks. While the positive broad-based global upswing is likely to continue, yields are still at low or negative levels and we expect them to stay low in Europe and Japan in 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 given that such strategies can offer 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

We believe that the integration of material sustainability criteria leads to better informed investment decisions through the identification of growth opportunities and the management of long-term risks.

Any company focusing on the long term must also take account of the world’s environmental and social challenges that are driving demand and are a source of long-term risk. Therefore, we have established a material approach to sustainability which focuses on those environmental, social and governance (ESG) factors that underlie successful long-term investment strategies.

Our dedicated sustainability research team collaborates with our fixed income and equity analysts to embed sustainability information within our existing global research platform. This allows our investment teams to identify long-term opportunities, manage risks and make better-informed investment decisions.

Focused sustainable investing consists of three distinct approaches that can be used individually or in combination when building portfolios:

  • exclusion of objectionable investments
  • integration of ESG factors with traditional finance considerations to make investment decisions
  • impact investing

Exclusion and integration strategies focus on financial return while taking ESG factors into consideration. Impact investing is geared towards generating a measurable positive impact alongside a financial return.

For 20 years we have been developing sustainable investment solutions for institutional investors across the globe. Backed by our significant expertise, proprietary sustainability data, and a sophisticated research platform, we build tailored strategies for institutional investors that help them meet both their financial and sustainability requirements.