What does it mean to be a long-term investor? That was one of the main questions underpinning the discussions at our Investment Forum in Frankfurt. Topics included the importance of climate change and the future direction of Europe, as our investors and strategists shaped the convictions that inform our long-term investment strategies for clients.
Sustainable investing is about more than climate change: it helps to improve corporate governance and make business models more sustainable, as investors increasingly focus on real-world impact
Taking risk remains essential for investors who want to avoid seeing the value of their investment eroded – but it’s important to make smart choices based on fundamental research and keep a close eye on valuation metrics
Against a more muted outlook for returns, being diversified and adding alpha to beta is key – especially as beta returns are set to be lower and more volatile
Alternative investments can help improve performance and risk profiles: active managers can guide investors on using alternatives, depending on their specific investment objectives
Be active and countercyclical to seize opportunities, balancing the need to be opportunistic while also looking far enough ahead
The Forum’s opening sessions concentrated on climate change as part of a broader discussion of sustainable investing that reflects investors’ increasing focus on this area. After nearly two decades managing sustainability-focused portfolios, we have demonstrated to our clients that environmental, social and governance (ESG) factors can help improve risk/reward profiles. This is an important reason why sustainability has become a core consideration for many investors, particularly large institutions. Looking ahead, investors will increasingly focus on how they can deliver real-world impact through the way they invest.
The urgency surrounding climate change in particular has focused more investors on sustainability. Increasingly, businesses will need to factor in climate-related regulations – there are nearly 1,500 policies and laws related to climate change in effect worldwide – and public scrutiny will arguably exert even greater pressure. The goal of many of these regulations is both to influence companies to change their behaviour, and persuade investors to direct capital in ways that have a positive real-world impact. Regardless of investors’ personal views on climate change, any company that operates globally will inevitably face increased scrutiny on this issue.
Moreover, sustainable investing is about more than climate change: it helps to improve corporate governance and make business models more sustainable. Through our integrated ESG approach, we gain a deeper understanding of the risks that could affect a company’s performance throughout its value chain. And we’re able to work with companies that may have low ESG ratings to improve their standing and, consequently, their return potential. Indeed, as an active investor, engaging with boards and management teams to set clear targets and improve governance is integral to our value proposition.
We have also seen rising awareness from clients looking for impact investments – combining stable returns with a specific social or environmental benefit – especially from the younger generations who will become increasingly powerful investors.
Major growth expected in impact investing
Source: GI Hub investment estimates; GIIN Annual Investor Survey 2018
While the global economy continues to muddle through its late-cycle stage, bouts of market volatility have unnerved many investors and, seemingly, the US Federal Reserve. To stimulate growth and inflation, central banks globally are keeping interest rates lower for longer, with the prospect of near-term rate cuts now priced in in the US. While this monetary policy stimulus is likely to support asset prices in the long run – making any setback in risk assets a potential buying opportunity – it is important to take into account valuations.
The low rate environment has the knock-on effect of suppressing the yields of government bonds, but it hasn’t deterred investors. In fact, Bloomberg recently estimated that investors own nearly USD 10 trillion in negative-yielding bonds. Some investors are so risk-averse that they willingly let their portfolios steadily lose value in “safe” investments and fail to protect the purchasing power of their savings.
One of the factors making investors nervous is the state of global trade and the prospect of trade war. US President Donald Trump has met with some success in using tariffs as a negotiating tactic – although, in the case of China, his efforts have met with sufficiently little movement that we now put the odds of a favourable trade deal at just around 50/50. Chinese President Xi Jinping has too much at stake with his “Made in China 2025” plan— designed to move Chinese manufacturing into value-added areas areas such as technology and clean energy— to let the US get its way. In addition, even if Mr Trump’s anger is currently directed at China, investors should not rule out the prospect of him imposing tariffs on Europe and other traditional US allies.
With elections coming up in 2020, and the increasing likelihood of a US recession that year, Mr Trump will look for other ways to motivate his base – more proof that political risk is important for investors everywhere to watch. Still, we are convinced that it would be a mistake – if not outright impossible – for investors to avoid risk altogether. We believe investors must take some risk in order to earn a reasonable return, but they should be selective and manage risk actively – using fundamental research to make insight-driven decisions and incorporate ESG factors.
Despite the late-cycle backdrop, opportunities exist for investors. US equities have done well recently, with major indices posting double-digit returns this year following a rough fourth quarter of 2018 – but this may be an unsustainable growth rate. Our research indicates that US equity and bond markets are likely to produce lower returns and be less correlated in the next 10 years. Furthermore, non-US bonds are also likely to generate low returns while non-US equity returns are set to hover around the levels experienced over the very long term. Adding alpha to beta is key – especially as we believe beta returns are set to be lower and more volatile. And, given the more muted return outlook, investors may want to reconsider their overall asset allocation in light of their long-term objectives.
Where should investors turn? Here are some ideas:
Alternative investments have the potential to improve investment performance and risk profiles. Liquid alternatives are a good diversifier given their historically low correlations with equities and bonds. Illiquid alternatives can offer a potentially interesting extra return – the illiquidity premium – in times of low interest rates, and we are seeing significant investor interest in infrastructure equity/debt and private equity/debt. As active asset managers, we play a role in helping guide investors on how alternatives can help them meet their investment objectives, particularly as the available universe of alternative assets expands.
Income-generating investments are designed to provide a range of benefits to portfolios – from more stable, predictable returns to a lower risk profile. Attractive income potential can be found in a range of “riskier” assets. Consider dividend-paying equities, higher-quality high-yield bonds (particularly in the US and Asia) and emerging-market debt. Longer-duration assets may also be a smart choice in the near term, given their ability to hedge equity-market volatility.
Differentiation between regions and sectors is increasingly important. As the interest-rate cycle peaks and concerns grow around the global economy and trade tensions, valuations become a more critical metric. On this basis, we see attractive opportunities in European, emerging-market and Asian equities. Furthermore, equity income may be more powerful than equity earnings growth for the next few years.
Europe has been unloved by investors for some time, but we see strong potential there, particularly with the European Central Bank committed to keeping the economy moving. The relative dearth of leading global tech firms domiciled in Europe does not equate to a lack of investor growth opportunity – Europe has a strong line-up of leaders in product and service innovation and a record of start-up successes in the technology sector. The region could, however, benefit from deeper capital markets and more fiscal stimulus at the national level. Investors should of course be aware of how the EU may be caught in the crossfire of the trade wars and new US-China “tech cold war”, but Europe could also be one of the winners from the ensuing disruption to value chains.
Market timing may also be an option for active investors. In a volatile yet sideways-trending market, the strategy can be an additional source of return potential.
US equities look expensive based on historic norms opportunities
Shiller PE S&P 500 (price/10-year earnings average): current level at 29.8
At a CAPE of 29.8, the S&P 500 trades ~1.88 standard deviations above the historic norm. Past performance is no guarantee of future results.
Source: AllianzGI, Robert Shiller, as at May 2019.
We expect any number of forces – from central-bank actions to political uncertainty to classic mean-reversion – to generate more market volatility. Prior tailwinds may turn into headwinds as price-to-earnings ratios peak and low interest rates squeeze future returns. Investors may hold "safe", low-returning assets or consensual long US assets because they felt they had little choice, but in fact they have many options.
This is a compelling reason for investors to consider an active asset-management approach when setting the optimal “risk mix” within a portfolio – particularly since passive investments participate fully in every market decline as they track their underlying indices. Procyclicality – the tendency to follow the herd or track the cycle – is potentially one of the biggest destroyers of value. Yet good active managers have in-depth knowledge of companies, industries and markets that can help them seek out above-market returns and understand where future potential performance lies.
Much of active managers’ knowledge is derived from fundamental research, which can be particularly helpful when markets are turbulent. Consider the value of proprietary research into a company’s supply chain during a time of trade disputes and geopolitical tensions: it can help investors seek out the winners while aiming to avoid the losers. Research can also help investors set more reasonable long-term return expectations, and pay the right price for the right investment.
This last point is an important one, because today’s markets have an upside as well as a downside. That’s why it’s critical for investors to be opportunistic while looking far enough ahead: with a long enough time horizon and an active approach, they are more strongly positioned to weather all kinds of market environments.
Neil is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances.
Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager.
Neil has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.
It looks increasingly unlikely that the US and China will reach an amicable agreement to end their ongoing trade conflict. If tensions between the two countries continue to escalate, we could witness the end of a decades-long period of globalisation – with several major implications for investors.
It seems there are good reasons for the leaders of both the US and China to avoid backing down in their ongoing trade dispute
Higher US tariffs on imports may drive up inflation, which might compel the Fed to hike rates, boosting the US dollar but hitting US growth expectations and emerging-market assets
The use of the dollar as an economic weapon may see the currency strengthen in the short term; this could undermine its appeal as the world’s reserve currency over a longer horizon
China might retaliate with a “don’t buy America” policy, hitting US corporate profits for decades to come, and by denying US companies access to critical China-based supply chains
Countries around the globe are likely to come under pressure to choose sides in the dispute, resulting in an increasingly polarised world
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