Category Investments

Is it too early for predictions?

04 May 2021 Myra Knoesen
Robin Parkbrook

Robin Parkbrook

Ugo Montrucchio

Ugo Montrucchio

The investment world looks very different today, compared to what it looked like in the past, and it requires investors to challenge pre-conceived notions, according to Robin Parkbrook, Fund Manager and Co-Head of Asian Equity Alternative Investments at Schroders.

Speaking at Schroder’s Investment Symposium, Parbrook highlighted three ways in which the investment world has changed over time, and how investors can prepare and adapt.

Inflationary pressure

“There are plenty of signs that inflationary pressure is rising. The question is whether these inflationary pressures are structural or a temporary blip,” said Parbrook.

“Current monetary and fiscal policies may overwhelm the 4Dsdemographics (aging population and shrinking working-age group is deflationary), disruption (GDP slows, not accelerates, during industrial revolution. Tech disruption is a threat to all workers), disparity in income (high income earners save more. Income inequality means higher savings) and debt and (not much) deleveraging (almost all parts of economies now have higher leverage than before GFC),” said Parbrook.

“Two or three years out I don’t think inflation is going to be a structural phenomenon. I think the four Ds will re-assert themselves, especially disruption and debt,” he said.

BEVI bubbles will burst
“There’s been a large increase in retail investor participation in stock markets across the world. Retail money is flowing heavily into popular themes such as biotech, electric vehicle, and internet stocks (BEVI). I am getting increasingly worried by the tone of the broker notes, especially on the electric vehicle (EV) side,” said Parbrook.

“An EV is essentially a generic good with standard technology that is relatively easy to use. These are in essence simpler and better cars than traditional combustion engine ones, but like smartphones and flat panel TVs - great new products don’t make money for manufacturers when there are too many players with almost identical products,” emphasised Parbrook.

Old-style value investing is dead
“Relying predominantly on classic value measures like price-to-book and trailing price-to-earnings ratios no longer works, because intangible assets have become more important. Intangible assets are things like research and development, brand building, building a sales network – things that cannot easily be quantified in the same way as the classic value measures can,” said Parbrook.

“In a rapidly changing world, asset heavy companies may struggle where they compete with new economy stocks. Countries and stock markets where intangibles are large and growing are likely to do better. Those companies that are investing heavily into intangibles will be the likely winners. You cannot differentiate between stocks simply on traditional value measures like book value because you are not accounting for the value that lies in the company’s intangible assets. We have to work out which companies are investing well in intangibles and are really building businesses, because we can’t see these investments and potential growth just by looking at the reports and accounts,” added Parbrook.

Developing “what if scenarios”

“We are moving from the 20th century industrial era to the 21st century information age and it’s a very different and challenging world. It is more important than ever to think long-term and consider ‘what if’ scenarios as disruption is only going to accelerate, not slow, from here,” said Parbrook.

“An internet world that is more data driven and “virtual” is very different - portfolios have to adapt to this - the Emerging Market world and growth model has changed,” added Parbrook.

In his concluding remarks, Parbrook said, “an inflation scare is likely to prick the BEVI bubble - we are not optimistic 2021 will be a great year for stock markets. The world is changing fast, and COVID-19 looks to have accelerated many trends. The importance of intangible assets has changed the way we need to think and evaluate companies. EMs face their own set of challenges. China looks set to dominate this universe, but America and the West will try and check it is rise. This could be messy.”

No clear-cut answer

Ugo Montrucchio, Multi-Asset Fund Manager at Schroders said, “much has changed in financial markets over the last 73 years, but there are a number of lessons we can take from past experience.”

“Firstly, history suggests that during periods of low and stable inflation, a negative correlation between equities and bonds exists. The resulting low and relatively stable interest rates have amplified the diversifying role of bonds in a portfolio. However, in a world in which inflation comes back, this role may be challenged. When inflation is high, history suggests there is a positive correlation between equities and bonds. In this environment bonds may struggle to act as effective diversifiers. Investors will, therefore, need to think harder about how to go about creating a diversified portfolio – they can no longer rely on bonds to diversify equity risk,” he said.

“Secondly, our analysis suggests that during an economic recession or recovery, the dispersion of returns from various asset classes increases and asset allocation matters more than stock selection does. Meanwhile, when an economy is in its expansion phase, history tells us that stock selection contributes more to returns than asset allocation. Therefore, we believe there’s merit in being flexible with one’s investment strategy, varying asset allocation throughout the economic cycle,” added Montrucchio. 

“Thirdly, liquidity has been a major driver of financial market returns, especially over the last 10 years. Prior to the last crisis (the global financial crisis of 2007-2009), the US Federal Reserve’s balance sheet was stable, but in 2008 it started pumping liquidity into the financial system to rebuild banks’ balance sheets. This fed through into financial markets, but not into the real economy. This time around, with monetary policy accommodative in most of the world, the baton has passed to fiscal policy to support ailing economies. We’re likely to see this transition from monetary expansion to fiscal support play out over the next five years,” continued Montrucchio.

“Fourthly, the combination of monetary and fiscal stimulus could create inflation. With generous fiscal measures directed at consumers rather than the financial system, we could see inflationary risks increase in the developed world. Especially as this money feeds through to significant consumer spending over the next few years. But it is too early to predict whether this will happen with any certainty,” he said.

“Fifthly, regulation and cost pressure are also here to stay. One aspect of this is the debate about active versus passive management. The passive versus active debate is raging. However, the debate misses the point that there’s space for both active and passive in a portfolio. There is a very strong case for using a blend of active and passive. A passive approach is very effective in providing access to efficient markets, while active managers can add value particularly in inefficient markets,” added Montrucchio.

“There’s also no clear-cut answer to the question of whether technological advancement and quantitative easing have inflated markets to bubble territory. I do believe we could very well be in a bubble, but it is localised in certain areas of US technology stocks. To my mind, the bubble is not so much in the large cap technology stocks, the FAAANM (Facebook, Apple, Alphabet, Amazon, Netflix and Microsoft) stocks of this world. Rather I think the bubble could be in the second-tier technology stocks which are trading at lofty valuations and whose revenue projections are overambitious. The best way to navigate through what may well turn out to be a bubble, is to diversify your exposure and cast your investing net as wide as possible,” said Montrucchio.

“Lastly, sustainability will grow in importance. As investors we will have to tackle important issues like stakeholder management and how we navigate the transition towards a low carbon economy. People are taking more active steps to move towards more sustainable investment approaches. It’s equally clear to me that the scale of the problem we face is immense and that it will have profound implications for how we allocate capital in the years to come,” concluded Montrucchio.

Writer’s thoughts:
COVID-19 has accelerated trends and from the signs and issues raised from past experience, all investors can do is prepare and adapt as there is no clear-cut answer and, as mentioned above, it is still too early to predict while there is still so much uncertainty. Do you agree? If you have any questions please comment below, interact with us on Twitter at @fanews_online or email me - [email protected].

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