Three ways the world is changing, and how we’re investing as a result

One of the many strange phenomena of the Covid era is that on the one hand it often feels as if the world has stood still - as if normal life is in suspension – but on the other hand seismic shifts have been happening while we quietly work from home. The adoption of technology has sped up remarkably, climate change continues to wreak havoc across the globe, geopolitical tensions have been heating up and central banks have poured unprecedented amounts of liquidity into markets. In other words, broad and sweeping changes are happening, but our experience of them is limited mostly to what we see on our computer screens, and the occasional conversation about the weather.

Further confusing the picture for investors has been the sheer amount of noise and momentum we’ve seen in markets over the last quarter. It’s in moments like these that investors can often feel as if time is slipping away from them, as if a window of opportunity is narrowing and they have fewer and fewer chances in which to act. We know what follows, noisy markets lead to poor investment choices – whether buying into a bubble or catching a falling knife – and we know that emotional decision making is to blame. But the reality of the matter, while far less exciting than trying to second guess choppy markets, is that investment time is slow. Real change, the kind that shapes returns over time, takes too long for the average investor to be mindful of. Luckily for us, our clients are not ordinary investors. For one thing, they have the luxury of time; freed of short-term targets, they can be strategic and forward looking with their capital. And for another, they aren’t limited to only a handful of asset classes, they have options.

So, let’s assume that there is no market noise, and that this is a still point in time in which to explore the real changes underway that are likely to shape portfolios in the years and decades to come. What are the key dynamics, and how might an investor with a long time horizon and the ability to invest in any class they choose, construct a portfolio around them? Furthermore, how do you invest in such a way that doesn’t just protect you from change, but allows you to benefit from it? Let’s explore three such themes.

Central banks have been pumping extraordinary amounts of liquidity – unprecedented in peacetime – into markets merely to keep the global economy afloat. There are countless ways that this is will affect markets and portfolios over time, but here are two. We are already seeing the first one; yields have been compressed to such an extent that investors with short term targets to meet have been forced to turn to growth instead, and with growth scarce courtesy of the economic slowdown, those few companies that are able to grow through this crisis are attracting a huge concentration of flows. The second one is that while the fiscal and monetary stimulus packages have done enough to keep things moving for now, we will eventually have to pay for it. The easiest way for governments to do that - is to let inflation run high enough to ease the debt burden.

Knowing these two things, what would the investor with the option to invest in any asset class, and freed of the need to chase yield, look at now? Firstly, our approach is to build inflation protection into portfolios while it is relatively inexpensive to so do. Secondly with value equities now at their cheapest compared to growth since the dotcom crisis, we are tilting our exposure towards value, while still capturing market momentum through options.

If you’re looking for a lesson in strategic patience and timing, look no further than China. We’re all used to a world where a single power – the US in this case – has been the driving force behind global growth. But that is changing, demographics alone point to a scenario where China challenges the US’s relative share of global GDP in dollar terms, if not already on a purchasing power parity basis. From a Chinese perspective, this is not necessarily a rise to power, but a return. If you were to look at global GDP over the last 2000 years, China’s share – alongside India – was pretty dominant for a major proportion of that time. It’s only since the Industrial Revolution that the game changed, powering Europe and the West through rapid technological advancement.

Now there are negative potential effects for investors, namely the decline of globalisation leading to lower growth, and the not insubstantial threat of serious conflict. But there are also opportunities; in a world where global megaliths no longer take the lion’s share of profits, domestically focussed businesses could be primed to take up the slack. Chinese A shares have already been strong performers, and we have been increasing our positioning, which not only allows us to tap into rising growth, but also provides a healthy counterbalance to the US. If you were to look at indices now, with the US making up c.70% of the MSCI World Index, you have to ask yourself if, in a world where the dollar is structurally weakening and China is on the rise, is this is a sustainable position? If you don’t think it is, then a more balanced approach is required.

This is a weighty issue to pack into a portfolio, but long-term investors cannot afford not to. In much the same way as investment time is so slow that investors often miss the real inflection point, the gradual erosion of natural resources and heating of the planet has been happening for generations, but is now speeding up to such a point that we are seeing devastating effects in real time. In the last few months, we’ve seen forest fires tear through Australia and California, and a 110 square kilometre stretch of ice break away from the Arctic’s largest remaining ice shelf. Events like these have propelled climate change to the forefront of social and political agendas in recent years, and policy has picked up accordingly. According to environmental economist Dmitri Zenghelis, climate related laws across the world have doubled over the last six years, alongside the rapid creation of new lobby groups and environmental thinktanks. Meanwhile in the corporate world, investor pressure has led to companies putting their ESG credentials at the forefront of their communications.

Consumer pressure to demonstrate sustainability in business practices has also picked up, and we’ve seen this first hand through both our commercial real estate and direct private equity operations. While policy pressure is still growing in this area, it is our clients who are driving the push towards creating greener spaces.

The ramifications for investors and business owners are widespread and seismic. While climate change is a frightening issue for us all, in investment terms it creates both risk and opportunity. In order to manage risk, you need to think about everything from the potential of damage to physical assets from extreme weather events, to the potential obsolescence of some fossil fuel companies. But in terms of opportunities, we see the shift towards renewables as a potential boon, rather than a drag, on economic growth. For us, this doesn’t mean taking speculative positions in renewable stocks, but instead in deeply embedding ESG factors into every facet of our investment process, from economic analysis to working closely with our managers. In short, this issue is now so fundamental to our way of living and working that it is no longer a subject that you can overlook, not as an individual, and certainly not as an investor.

The key dynamic in global markets continues to be the dislocation between elevated asset prices, and a lack of economic backbone. On the one hand, this is not surprising; with bond yields compressed and even potentially negative, and corporate dividends scarce and under threat, investors have been forced to turn to growth in the absence of yield. And in a world where growth is scarce, it is the companies which are deemed to be “winners” in a partially locked-down world, that are attracting the lion’s share of capital, that is – tech stocks. Speculative retail investors may be adding fuel to the fire, but there are clear-cut macroeconomic drivers behind the momentum we’re seeing in certain areas of the equity market.

For investors who don’t need to chase short term yield, there are more balanced ways to manage capital at the moment, particularly when you have access to asset classes outside of equities and bonds. We have a relatively low weighting to cash equities, which are tilted towards value and quality stocks, and are making use of options to tap into broader equity market momentum without taking on the price risk. Alternatives and liquid real assets are playing a key role in portfolio diversification; we are underweight duration, and overweight liquidity, with sizeable positions in treasuries, inflation linked bonds, and an increased position in gold.

In terms of geographical allocation, global politics are complex, but our approach is relatively straightforward; global indices and benchmarks are already heavily skewed towards the US, and the world is looking increasingly fragmented, so we are particularly interested in opportunities outside of the US, and in domestically focussed equities. In particular, we have been increasing our exposure to Chinese A shares through an active manager, to make the most of the wide dispersions between winners and losers in that market. In terms of regional allocation within fixed income, we think that both US government and Chinese bonds are likely to offer stability as safe havens in each power block, albeit with low yields at this point in time.

While the uncertainty of the economic environment at the moment warrants caution in investment strategy, there are ways to ensure that portfolios can not only be resilient, but also benefit from ongoing volatility. These include our use of options, but also – within certain portfolios – long volatility strategies, which are designed to capitalise on market volatility through options and long/short positions. As we move through what is increasingly looking to be a highly fragile and piecemeal economic recovery, we think it prudent to build anti-fragility into portfolios in this way, and ultimately try to smooth out the return trajectory for our clients.

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