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Major trends and themes shaping future local and global investment decisions

23 November 2021 Alexander Forbes

The Covid-19 pandemic has accelerated significant changes in existing global investment trends, some of which will either change or recede as normality returns with more being vaccinated. However, some trends are here to stay.

Janina Slawski, head of investing consulting at Alexander Forbes, highlights key trends impacting investors:

Responsible investing

Flows to ESG funds have been significant across both active and passive funds. The European Union’s Sustainable Finance Disclosure Regulation (SFDR) came into effect on 10 March 2021 and is driving significant flows into ESG-labelled funds. The directive falls under the European Union’s and United Nation’s 2030 Agenda for Sustainable Development. It aims to:

• drive €1 trillion into green investments over the next decade
• address the lack of consistency in the climate-related information currently provided by financial-market participants
• provide a competitive edge to those firms offering genuinely sustainable products

SFRD has driven a rush by investment firms to label products as “sustainable” as they seek to gain a share of the booming market that hit a record $2.3-trillion in the second quarter of 2021.

Clients will focus more on financing true impact, with increased demand for green bonds, sustainable equity strategies and other products that contribute directly to environmental or societal change. Investors will increasingly accept the need for urgent climate action, while cross-country collaboration on specific issues will increase. Investors will use more tools to influence companies and regulatory action will reshape the industry.

Passive investing

Passive vehicles’ lead will likely expand in the $11.6 trillion US domestic equity fund market. Passive investing overtook active investing around August 2018; its current market share stands at about 54%. At least 42% of non-domestic assets are passive. The $6.2 trillion in passive assets still accounts for less than a sixth of the US stock market, with its market cap of about $40.4 trillion.

Cryptocurrencies vs gold

The world has seen a vast expansion in money supply since gold standards were abandoned. Cryptocurrencies have a market cap of about the same size as the market cap of US small cap stocks as represented by the Russell 2000 index. Bitcoin is predominant among crypto assets and offers some acceptance as a digital “store of value” or “digital gold”. There is no central authority to tamper with supply, and Bitcoin should therefore benefit when authorities print more traditional
money. China dominates as it has the largest percentage of hash rate (mining power) at 65.1% with the next highest being America with only 7.2%. The market is vulnerable to manipulation by “wash trading” (essentially trading to yourself to create artificial activity), and regulation is still limited depending on territory and type of activity.

Gold in contrast has been a traditional store of value. It has typically protected investors from large equity market falls in a low interest rate environment (bonds take this role in an environment of normalised interest rates). Conversely, when gold has done badly, the rest of a portfolio tends to do well. The tech bubble bursts and Covid-19 crash events were examples where gold equity provided a great, leveraged return. It is becoming increasingly possible to access responsibly sourced gold to manage environmental concerns.

Investing after the Covid-19 pandemic

As the global vaccine roll-out continues, we are moving into a new world and the impacts of change are global, says Slawski. She holds the following views about investing after the pandemic:

• Markets moving sideways
The economic recovery is looking entrenched, but markets could easily start moving sideways. Although the massive stimulus is still keeping economies buoyant, higher inflation and rising bond yields seem likely. The 2020 surge in savings is unlikely to continue and the pandemic’s end is already priced in to record high valuations.
• Inflation
Several factors are threatening to revive inflation. Whether current inflationary pressures are permanent or transitory is debated extensively.
• Easy money will dry up
Central banks are expected to tighten again, starting with reduced bond buying.
• A post-dollar world
Whilst the dollar is still the undisputed reserve currency, cryptocurrencies are emerging as a potential medium of exchange.
• Commodities
Commodity prices have declined steadily in real terms since records begin in the 1850s. However, that long decline is punctuated by boom decades. Although there was great excitement about the strong returns in 2020, it is questioned whether this will continue.
• An emerging market comeback
An emerging market comeback will be driven by:

- any continued revival in commodity prices
- growth among a few select emerging countries (concentrated in Eastern Europe and Southeast Asia) that are still growing on the back of export manufacturing
- market-friendly economic reforms
- the adoption of internet technology after the Covid-19 pandemic

• Rising challengers
E-commerce giants have made huge gains in recent years, but the market capitalisation of smaller, popular rivals is showing faster growth.
• New media habits
The pandemic has changed the market for online purchasing and entertainment, and this trend is expected to continue.

China

China is growing in significance in terms of global GDP but is still significantly under-represented in global indices. The portfolio benefits of onshore China (China A-shares) include:

• higher economic growth that could drive higher earnings growth and valuations
• greater alpha potential given market inefficiencies
• low correlation between onshore China and other equity markets

China and emerging markets should be a much larger share of MSCI ACWI, with investors potentially allocating direct allocations to China going forward.

Nimisha Bhawan, head: investments advisory, notes that in order to address some of its challenges, China is willing to take ‘short-term pain’ to improve longer-term prospects. China understands the importance of the private sector as a key driver of growth for the economy.

Although China is experiencing risk of further regulation and uncertainty is abundant, there are long-term opportunities since the size of its domestic market and higher R&D spend support economic transformation and technological advancement. The tech boom is also helping traditional industrial and manufacturing sectors.

Macroeconomic themes

Gyongyi King, chief investment officer at Alexander Forbes Investments, identifies the following dominant global themes:

• Global real estate was the best performing asset class year to date
• The Delta variant has created further market uncertainty
• Growth fixed income has outperformed defensive fixed income
• Inflation risks may force central banks to restrict monetary policy
• China’s regulation, economic slowdown and specific market events have impacted markets

According to King, “Asset allocation (overweighted in growth assets) was the key driver in outperformance outcomes year to date and over one year.” Strong absolute returns continue, but there are signs that these are beginning to tail off. Policy actions (or errors) are expected to drive market volatility in the near term in China as well as in the West.

Cyclical asset returns have begun to tail off, with signs of returns being difficult to come by. Markets have moved to the mid-cycle as the global economic recovery continues to make gains, but at a slower pace than previously. The return of inflation if permanent is a significant risk to asset classes and economic recovery.

It is important for South African investors to consider global investing in the context of their objectives, the opportunities that the global themes present, the diversification benefits that can be obtained, as well as risk and long-term desired outcomes.

Quick Polls

QUESTION

The second draft amendments to Regulation 28 will allow retirement funds to allocate up to 45% of their assets to SA infrastructure, with a further 10% for rest of Africa; but the equity & offshore caps remain unchanged. What are your thoughts on the proposal?

ANSWER

Infrastructure? You mean cash returns with higher risk!?!
Infrastructure cap is way too high
Offshore limit still needs to be raised
Who cares… Reg 28 does not apply to discretionary savings
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