by Emma Wallis
The Buy-Side Club looks at the year ahead, examines market forecasts, and evaluates this year’s major investment trends
Investors are entering 2019 in a climate of caution and uncertainty, amidst concerns over US-China trade tensions, Brexit and monetary policy. As a result, many investment professionals and commentators expect volatility to pick up this year. Meanwhile, several broad trends are set to persist, including the popularity of ESG and impact investing, diversification into alternatives, technological advances and margin pressure.
Market downturn fears: Investors are becoming increasingly concerned about a downturn in the economic cycle. As a result, two-thirds (68 per cent) of BlackRock’s large institutional clients in the US and Canada, and 27 per cent in Continental Europe plan to reduce their allocations to public equities this year.
Willis Towers Watson (WTW) expects monetary tightening to result in slower real growth and rising downside risks. “We believe that a recession is more likely than not over five years,” the consultant stated in its December 2018 Global Markets Overview. “Relative to our medium-term outlook, we think valuations for growth-related assets are high and expect low returns on average.” WTW recommends that its clients prepare for a lower return environment by maximising diversity and alpha capture, allocating to assets that provide downside protection such as levered bonds, and considering well-designed options strategies as a cost-effective alternative to outright de-risking.
FTfm interviewed several fund management CIOs in December 2018 who sounded warning bells about high levels of corporate debt and tighter liquidity. Anton Eser, CIO of Legal & General Investment Management, said the next downturn could be triggered by over-levered corporates who are unprepared for slowing economic growth and technological change. Although valuations have come off the boil, investors should be wary of catching a falling knife, he warned.
Other managers delivered more upbeat forecasts, however. “The return to a normal economic environment, combined with healthier valuations, should mean that financial markets, and especially global equities, deliver positive returns in 2019,” wrote Chris Cheetham, CIO of HSBC Asset Management. “I am reminded of the story of the tortoise and the hare. It is unlikely that investment returns will be stellar [this] year so it won’t be possible to run very quickly. However, the market correction [in 2018] should mean that patient investors can expect to achieve steady returns in the medium to long-term.”
Brexit and the new ‘big short’: Steve Eisman (famous for anticipating the US subprime debt crash and portrayed in the movie ‘The Big Short’) is shorting three UK banks and betting that the UK stock market will fall due to Brexit. Investors tend to underestimate downside risk when the scenario is too horrible to contemplate, he told BBC Radio 4 on 16 January 2019. In the same vein, Odey Asset Management and Marshall Wace, whose respective owners Crispin Odey and Sir Paul Marshall both backed Brexit, have taken short positions against companies exposed to the UK consumer, including retailers, estate agents and banks.
Richard Buxton, Head of UK Equities at Merian Global Investors, also believes that “continuing uncertainty over Brexit will remain a significant ‘handbrake’ on the UK economy and UK stock market. Only when certainty over the UK’s future relationship with the EU emerges is business confidence and investment, and indeed consumer confidence, likely to return. Until such a time, the ‘handbrake’ will, I believe, remain obstinately jammed. Any extension of the Article 50 process would, in my view, simply perpetuate the present impasse.”
Volatility: Market volatility is expected to pick up this year, which could throw up opportunities for active stock pickers, according to Hermes Investment Management’s CEO Saker Nusseibeh: “In some ways, we are returning to more ‘normal’ historic trends with a tension between growth and interest rate hikes and a dislocation of correla[tions] between asset classes and regions, which in turn implies two outcomes: stock picking and asset allocation will reassert their ability to add to returns, and the mass moves to index funds and ETFs will probably coincide with a period of their underperformance compared to high active share alpha hunting strategies.”
Alternatives: As they move out of public equity markets, investors are diversifying into illiquid alternatives in pursuit of uncorrelated returns. Over half (54 per cent) of BlackRock’s institutional clients globally intend to increase their exposure to real assets this year, 56 per cent to private credit, 47 per cent to private equity and 40 per cent to real estate. A separate survey by INREV, ANREV and PREA found that six out of 10 European institutional investors intend to increase their real estate holdings, although most investors in the US and Asia Pacific do not expect to change their allocations.
Hedge funds suffered torrid performance in 2018 and are no longer seen as a safe haven. Only 16 hedge funds achieved positive returns before fees last year, from a universe of 450 strategies monitored by HSBC’s alternative investments division, as FTfm reported. The 10 largest hedge funds lost an average of 4.5 per cent after fees, trailing the S&P 500, according to eVestment. Most of BlackRock’s large institutional clients (66 per cent) plan to keep their hedge fund allocations static; 16 per cent will increase their holdings, while 18 per cent want to trim their exposure.
ESG: Investment strategies incorporating environmental, social and governance (ESG) factors are expected to attract fresh inflows. Indeed, 28 per cent of BlackRock’s clients said they plan to devote more attention to ESG and impact investing this year.
In the UK, pension trustees are obliged to update their schemes’ statement of investment principles by October to include a policy on how they take financially material ESG considerations into account, including climate change. This process is expected to move ESG discussions higher up trustees’ agendas.
Several asset managers are incorporating ESG analysis into the majority of their investment strategies and processes, including Aegon, AXA Investment Managers, BNP Paribas Asset Management, First State Investments, Kempen Capital Management and Robeco.
Asset owners and managers are also looking at impact measurement, for instance evaluating a portfolio’s carbon footprint. The Investment Leaders Group (ILG), a global network of pension funds, insurers and asset managers, argues that all investments have an impact on the real world, so impact measurement should be expanded to all portfolios. ILG is also pushing for ESG to become a central part of the investment process.
Sustainable investments that seek to make a positive contribution to society or the environment, as well as delivering financial returns, have attracted the backing of policymakers around the world. The European Commission’s EU High-Level Expert Group on Sustainable Finance published a far-reaching report in 2018, recommending ways to steer capital towards sustainable investments. The UK Government too is a strong proponent of impact investing and green finance. A number of fund managers, including Investec Asset Management, Hermes and Partners Group, have launched strategies addressing the United Nations’ Sustainable Development Goals.
Machine-led investing: From ‘quantamental’ strategies that marry quantitative techniques with fundamental investing, to managers such as BlackRock and Schroders seeking insights from big data and artificial intelligence, computer-driven investment approaches are here to stay. As a result, investment firms are seeking to recruit more financial engineers, computer programmers, strategists, statisticians and scientists.
Low-cost passives: Fidelity Investments threw down the gauntlet last year by launching passive funds without any management fees. The fund behemoth managed to keep its costs low by developing its own indices for these funds to track. As the race to the bottom continues for charges, self-indexing is likely to become more prevalent, FTfm predicted.
ETFs continued to see strong demand in 2018 – the second-best year on record for inflows – although global inflows were down by a fifth compared to 2017.
Margin pressure: Total and average costs for asset and wealth managers are rising at the fastest pace since the financial crisis, PwC reported in Q4 2018, and profitability is falling. PwC expects asset managers to focus their spending this year on increasing efficiency, speed and reaching new customers. The consultancy also predicted an uptick in M&A activity as investment managers seek to cut costs, add scale, gain expertise in new asset classes, and enter new distribution channels and markets.
Asset managers face “intense pressure on growth and margins,” McKinsey concurred. “The global asset management industry is on the brink of a once-in-a-generation shift in competitive dynamics due to five converging trends: digital, diminishing investment returns, heightened regulation, a shake-up in active management, and increased demand for alternative assets.” McKinsey recommended that asset managers respond by improving operational efficiency and reallocating resources to high growth areas. Retail and institutional clients expect better service (which technology can facilitate) and better value, McKinsey continued, “calling for a reengineering of investment distribution and the investing experience.”
Shares in all the FTSE-listed asset managers except for Miton Group fell significantly last year, in a reversal of fortunes compared to 2017. Stock-specific events at individual firms played their part, but these moves also reflected negative investor sentiment for the broader market, as Investment Week explained.
Regime change: “Two bull markets – the 30-year one in bonds and the decade-long one in US equities – appear to be ending, unwinding the asset class correlations that many investors have become used to,” as BNP Paribas Asset Management explained. Volatility, macroeconomic uncertainty, and regime change are on the cards this year.
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