Longer term themes

Longer term themes

UBS CIO sees value in emphasizing the long-term drivers of investment performance. This philosophy is central to our “Decade Ahead” series, which focuses on investing in enduring structural trends (e.g., population growth, aging, increased urbanization, resource constraints, innovation).

Long term theme as investments

We believe that investors who are willing to follow the insights of such long-term themes over multiple business cycles can benefit from potential mispricing created by the typically shorter-term focus of financial markets.

We have therefore established a framework to identify long-term investment opportunities that is broad and versatile enough to incorporate major potential sources of change in the coming decade. In this pursuit, we focus on the following sets of drivers:

  1. technological innovation; 
  2. demographic changes; 
  3. sources and uses of natural resources; 
  4. trends in globalization; 
  5. government policy choices; 
  6. economic normalization; and 
  7. societal and cultural shifts.

These drivers serve as a compass allowing us to identify and analyze more specific structural shifts. This, in turn, can help us determine growth areas and select investment opportunities best suited to capitalize on these trends, while avoiding areas of secular decline that may emerge simultaneously. In the remainder of this section, we highlight the more salient “Decade Ahead” themes, which we’ve written about during the last year.

Transformational technologies

Over the next decade, we expect a wave of technological innovation to drive productivity growth, disrupt industries, and create substantial growth opportunities. There are two broad categories of technological innovation that we believe will be driving forces behind productivity gains over the next several years: digital data and smart automation. 

Digital data growth is set to explode in the coming years, with the global digital universe likely to increase 50-fold from 2010 to 2020. This expansion is being driven by a combination of demographic factors, like rising global Internet penetration and increased data usage in emerging markets, as well as secular trends, such as changing consumer digital lifestyles and the rise of the Internet-of-Things (the vast network of connected devices, such as chips embedded in household appliances). Digital data travels through six stages during its life: creation, transmission, storage, processing, consumption, and monetization. We see opportunities to invest across this life cycle, specifically in data enablers, data infrastructure companies, digital marketing firms, and cybersecurity providers.

We believe smart automation is powering the ongoing industrial revolution, combining the innovation power of industrial and IT processes to drive global manufacturing productivity gains. Rising wages and challenging demographic developments will pressure the costs of manufacturing companies in the emerging markets, driving investments in automation. We expect the smart automation industry to post mid to high single-digit growth on average in the next decade, owing to strong growth in industrial software. Smart automation represents one of the fastest-growing segments in the broader industrial and IT sectors.

e-Commerce: Beyond Amazon

Explosive growth in e-Commerce continues to alter the consumer landscape. Omni-channel companies – those that are completely agnostic to how, where, and when a consumer shops or interacts with a brand – will lead the way. At an omni-channel retailer, all purchase channels are effortlessly connected, providing a convenient and seamless way to shop. Pricing is typically consistent across all channels, and purchases made online can easily be returned in store, and vice versa.

Long-term positive drivers of digital growth, including the rapid adoption of mobile devices, such as smartphones and tablets, will hasten market share-shifts online. The smartphone has become a disruptive force in retailing, with the majority of mobile transactions taking place on devices such as Apple's iPhone and the Samsung Galaxy. The digital shift has continued to gather speed, as the transition to mobile is happening even faster than expected.

Opportunities around the e-Commerce theme extend beyond just owning pure-play online shopping companies, like Amazon. US-based companies in consumer-focused industries, such as retail, apparel, consumer packaged goods, and restaurants, will benefit as they take an omni-channel approach to their business and as more consumers shift their shopping and spending online. In addition, to complement their online efforts, firms are using digital marketing strategies, including social media, search, and big data, to name a few. Companies that facilitate e-Commerce transactions, from IT providers to the payment of goods, should also be beneficiaries of the e-Commerce theme.

North American energy independence: reenergized

The past year-and-a-half has been turbulent for energy markets, and the growth trajectory in the North American oil and gas industry has been temporarily disrupted. Yet, we remain convinced that North America remains on a path toward energy independence. Through the price downturn, a combination of declining development costs and increasing operating efficiency has kept US onshore operators competitive on the global stage. Over time, we project a resumption of growth, albeit more modest, in the North American oil and gas industry.

We see three primary paths to energy independence: first, through rising US oil and gas production; second, through increased oil supplies from Canada; and third, as a result of conservation and diversification of our energy fuel base, including strong growth in alternative and renewable energy sources.

Not only do we anticipate more energy self-sufficiency in North America by the end of the decade, we expect that the US will soon be a net exporter of natural gas. Trends supportive of the oil and gas industry – such as robust drilling activity for oil and natural gas, infrastructure buildout, and widespread availability of reliable and affordable energy supplies – are driving opportunities for investors. Technologies for extracting oil and gas are leading to improved well productivity and reduced costs.

We believe the US competitive landscape favors the stronger operators. A potential shakeout among US shale operators could enable the more efficient operators to benefit from industry consolidation and to come out even better positioned to capture future growth opportunities. Meanwhile, we expect energy consumers to enjoy the ongoing benefits of lower-cost energy. In particular, industrial consumers not only have access to a low-cost and reliable energy resource, but also enjoy a cost advantage over their international peers who are reliant on more expensive imported gas.

Valuing your human capital

While most of our “Decade Ahead” themes embed a specific investment recommendation, our last two themes are part of our guidance on broader wealth management strategy topics. Human capital represents an important intangible asset class that should be considered alongside stocks and bonds when making significant investment decisions. Defined as the value of an individual’s future labor income, it tends to be the dominant asset class early in one’s professional career. As time goes by and income is saved and invested, human capital runs down, while financial assets grow. Once an individual has reached full retirement, human capital defined in this manner reaches zero.

Understanding the characteristics of human capital has implications for asset allocation. Human capital has features that are more bond-like than equity-like. Therefore, considering an individual’s entire net worth (including human capital) suggests holding allocations to stocks, with the allocations declining over time along a certain glide path. The specific path depends on the nature of an investor’s human capital – in particular, how risky and how related it is to stock market conditions. Human capital that is either riskier (e.g., an athlete) or more highly correlated with equity returns (e.g., a stock broker) will imply a lower share of equities over time than for relatively safe human capital (e.g., a tenured university professor).

Another insight from this type of analysis is that a permanent loss of human capital, through disability or death, can have devastating consequences for a household. Therefore, it is critical to protect the value of human capital through life and disability insurance strategies. Understanding how human capital evolves over time suggests that individuals should actually hold more insurance when they are young and human capital is greatest.

The rising Millenials

Millennials - the demographic cohort of individuals born between 1980 and 1999, now 16 to 35 years of age - continue to garner significant media attention for a number of reasons, particularly their sheer size. According to the US Census, this generation represents nearly one-third of the total US population. In addition, Millennials comprise the largest share of the current American workforce, according to a recent report by the Pew Research Center. Over the next decade, a majority of Millennials will enter the workforce, form households, start families, and approach their peak earning years. Given the large size and earnings potential of Millennials, we believe companies with positive exposure to this rising generation will experience a growth tailwind in the years to come.

While today's young adults exhibit some behavioral traits in common with past generations, different societal influences and economic circumstances distinguish this cohort in a number of ways. This is a generation of “digital natives.” Their passion for and fluency with technology are fueling growth in e-Commerce, social media services, and mobile applications. Additionally, easy access to information is leading to more informed consumption decisions that favor cost-competitive online retailers and wellness-focused brands. Finally, this commitment-free generation is renting in large numbers and supporting growth in “sharing economy” services. The types of companies that stand to benefit from this generation and, as a result, to outperform the broader market, are those engaged in mobile technology, social media, e-Commerce, sharing economy services, health and wellness, and multi-family rental housing.

Environmental opportunities

Humanity is facing environmental and resource-related challenges on a global scale, with food, energy, and water scarcity likely to remain ongoing concerns for the next decade. The global population is expanding at a rapid rate, and population growth weighs heavily on vital resources. This increase in population is compounded by growth in income per capita, especially in developing countries, and the ongoing trend toward urbanization.

These factors are increasing the demand for higher-quality foods, in particular animal protein sources, such as meats. Higher consumption of animal protein worldwide is challenging as it requires a significantly larger amount of land, water, and energy resources compared to that required by vegetarian diets. Similarly, economic development and the global phenomenon of urbanization have resulted in a surge of energy consumption and have added pressure on existing water infrastructure. These trends only exacerbate the burden on environmental resources. Improving current technologies to be more efficient, while simultaneously developing more sustainable solutions is essential to resource preservation.

These challenges, if considered carefully and holistically, can turn into a compelling source of investment opportunities around resource optimization and efficiency. Forward-looking companies are strategically growing business lines that provide products and services targeted to meeting these challenges. Consequently, a variety of environmental opportunities are beginning to surface that can be integrated into investment portfolios. These include investments in alternative energy, energy efficiency, water treatment, and infrastructure, as well as sustainable food production.

Beyond benchmark fixed income investing

Since the global financial crisis, fixed income investors have found themselves in a difficult environment. The headwinds facing the bond market are numerous and include near-zero rates in short-maturity instruments, a longer, drawn-out normalization cycle, and frequent bouts of volatility. Despite the prolonged waiting game, we still expect the Federal Reserve to begin raising rates by the end of the year.

The path to a normalized interest rate environment will produce headwinds for fixed income investors over a medium- to longer-term period. Higher rates will exert pressure on principal values, and low starting yields will lead to greater bond price sensitivity. Accordingly, future fixed income returns are likely to be more modest, with starting yield levels being a strong indicator of future performance.

We recommend diversifying bond portfolios away from traditional taxable fixed income benchmarks that are heavily government-weighted (i.e., Barclays Aggregate Index), and incorporating other types of “beyond benchmark” assets. We believe that diversifying high-quality bond portfolios and incorporating different types of fixed income asset classes outside of government segments should lead to superior risk-adjusted returns over time.

Investors can circumvent traditional benchmark shortcomings by increasing exposure to credit spread sectors, where the additional risk premium can help cushion the effect of higher rates. Further, investors should seek more flexible approaches to managing their fixed income portfolios. Flexible, beyond benchmark investing can be achieved through multiple approaches, including those that incorporate active fixed income portfolio management.

Liability optimization

We view the current market environment as an opportune time for investors to “optimize” their liabilities in order to add potential value to their balance sheets. Optimizing balance sheets is a custom decision that needs to be made within the context of many factors, including tax situation, time horizon, and asset allocation.

We view the current market environment as an opportune time for investors to “optimize” their liabilities in order to add potential value to their balance sheets. Optimizing balance sheets is a custom decision that needs to be made within the context of many factors, including tax situation, time horizon, and asset allocation.

Monetary policy after the global financial crisis dramatically reduced interest rates. The last remaining vestige of the financial crisis can be seen today in the low levels of prevailing rates. Low rates provide an excellent opportunity on the liability side of the balance sheet to lock in low borrowing costs and to express views on interest rates and inflation.

Debt serves many purposes on a balance sheet. For some households, debt is simply a resource for making large purchases that could otherwise not be afforded. Debt can also be used to add leverage to a balance sheet – an action that would increase the net worth of the household when the return on investment assets is expected to exceed the cost of the debt. Finally, debt can express an investment view. Adding debt or refinancing into longer-term debt obligations actually decreases the duration exposure of the overall balance sheet. If interest rates increase or inflation is higher than expected, such an action can result in a higher overall balance sheet value than doing nothing.

Utilizing low-rate debt, while keeping investment assets productive, could significantly impact a household’s net worth over a longer time horizon. Looking forward, the current cost of debt is likely to be outpaced by portfolio returns, which, after years of compounding, could lead to enhanced investment returns.

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Sustainable Investing

The Longer Term Investments section expands on a selection of sustainability-aligned longer term investment themes.

Click below to see how our framework to deploy those themes works.

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