Our diverse panel of experts debate which of the high-conviction propositions they heard during the day resonated most strongly - and which they disagreed with most - to help delegates think through the portfolio construction implications of what they have heard at Markets Summit 2020.
VUCA issues are going to increasingly drive market outcomes. Mapping out different scenarios is a must to check your biases, challenge your own, others' and consensus views, and generate investment ideas that will help manage VUCA and target the right opportunities.
The retail sector has historically been the 'go to' category for investors in real estate as shopping malls enjoyed strong and stable returns relative to other more volatile segments of the real estate landscape. Ecommerce has transformed the retail supply chain, pressuring retailers and shopping centre landlords. Many investors have preferred unlisted real estate funds for their perceived lack of volatility, however many will now find themselves with over-valued retail assets and the risk of redemptions being suspended. Using listed REITs, investors can still gain exposure to high quality real estate through Global REITs, which offer exposure to other sectors experiencing better growth prospects and benefiting from tech disruption.
Calendar 2019 will go down in history as one of the largest ever rallies for infrastructure securities, driven by investors seeking low risk assets trading at attractive multiples. The sector holds unique investment characteristics - assets are long dated in nature and monopolistic, providing essential services to society. Assets are either governed by regulation or hold very long dated contracts, generally protecting against inflation or a rising cost of equity. This in turn provides a high level of predictability to future earnings and stability of dividends. Infrastructure has become a very important pillar in portfolio construction as the understanding of the sector increases globally. Infrastructure indices has provided excellent returns comparable to global equities over the last 15 years with less volatility and a higher income stream. With an aging demographic seeking more stable outcomes, many investors have been steadily increasing allocations to capture the attractiveness the sector offers.
Low inflationary outcomes and very low interest rates are expected to remain in place for some time. This is despite the fact that global economic growth continues to trend upwards and private and government fundamentals remain intact. Depressed interest rates have driven strong returns from long duration assets with some investors questioning their market risk premium. In the face of current events creating some economic uncertainty, REITs have resisted the attraction of cheap credit and will continue to provide a safe haven that seeks to provide ballast to portfolios through moat-like assets and growing cash flows.
VUCA will be prominent in 2020. Investors, particularly retirees are facing a “Code REDD” with reflation, election, duration and disruption all key themes. The central question of whether 2020 will be a good year or not depends on whether the market chooses to focus on the positive developments in economic data and financial conditions that could lead to reflation on the one hand, or the negative impact ongoing trade tensions could have and doubts whether strong market performance can be sustained on the other. The reflation theme will win underpin the continuing outperformance of stocks versus bonds. In fact, duration risk has infected all asset classes lowering expected returns to low to mid-single digits for bonds and mid to high single digit for stocks. Therefore the implications for portfolios is, the reflation theme is favouring a rotation into more cyclical sectors, lower duration assets and lower rating bonds.
Equity markets favour “bond-like equities” at present. There is a significant risk in this behaviour – namely any rise in, or steepening of, yield curves. After years of commentary about populism, the defining feature of the phenomenon is not being priced by markets. Populists spend money! To date, the major fiscal impulse – Donald Trump’s tax cuts – appears to have largely inflated asset prices. However, there is a real chance that future fiscal impulses will be far more redistributive and inflationary. In a VUCA world, the consensus of “lower forever” may prove damaging. Practitioners should examine portfolios for slow or no growth equities, priced like bonds, whose attractions may be inundated by a wave of fiscal stimulus.
As the old certainties break down, the response from policy makers has been to stimulate economies. When it comes to returns, the liquidity provided is particularly evident in longer dated growth assets. In the context of the Australian market, Australian mid caps is the sweet spot.
Traditional metrics suggest equities appear overvalued, but other factors argue against this. Interest rates are currently very low, as are credit spreads. Together these make the borrowing cost for corporates low, the benefits of which accrue to shareholders. Also, economics expectations are improving, supporting equity prices. Moreover, the environment of low rates should continue due to capital expenditure being applied increasingly to IT and software. This injects capacity into the economy, which keeps inflation and interest rates lower, sustaining the equity advantage.
The world is always heading into an unknown future but the threats change over time. Some of the unique elements to today’s uncertainty are the political polarisation, experimental monetary policies and high debt levels that are clouding the direction for financial markets. The best response for investors when pondering a future that is always VUCA is to ground their decisions in investment basics. For stock pickers that means looking for companies with sustainable advantages that are mispriced. In short, looking for mispriced quality companies.
The early 21st century has been distinguished by two economic conditions: high debt, and low inflation. Traditionally, many economists have viewed that high debt should be accompanied by high inflation, but now some are arguing that the high debt environment will be a cause of low inflation. The factor not being considered and driving this divergence of views, is the implication of the type of debt on the broader economy. It is private debt growth that precedes inflation growth, and the rapid accumulation of private debt causes household balance sheet fragility, and therefore greater susceptibility to VUCA events. While there has not been a rapid accumulation of private debt globally, Australia is a clear exception, which investors must be alert to. High household debt places Australia in a fragile position for further disinflation, implying that bond yields will remain lower for longer. Investors should look to accumulate bonds and ensure portfolios have an appropriate defensive allocation in anticipation of the next downturn.
Trade Wars, the US Election, Brexit 3.0, natural disasters and pandemic risks are causing fear and uncertainty in Australian equity investors. Is now the time to go to cash? Throughout history, market commentators have speculated on timing the next market downturn. Selling shares at the right time can be lucrative, but as an investor, it is a high risk, low return strategy. The ‘big money’ is not made in the buying and selling. It is in the waiting. Today, ‘VUCA’ risks are elevated in the Australian equity market, but so are the opportunities. The key to capturing these is to cut through the short-term noise and focus on ‘what matters’ to long-term returns.
The current VUCA environment creates opportunities for investors to increase diversification and income in their diversified portfolios, using carefully selected higher yielding parts of the credit market.
The world has checked into Hotel California – a world where low interest rates are failing to stimulate demand and monetary policy is less effective. It’s a world that is structurally changed and from which we can check out any time we like, but we can never leave. For investors, the cost of checking in will be drawdowns that are less frequent, but more VUCA. Successful adaptation will require a re-think of traditional strategic asset allocation approaches; in particular a trade-off between asset classes that are traditionally negatively correlated to risk assets, and risk assets themselves.
US/China trade tensions and the recent coronavirus outbreak highlight that a VUCA world abounds. However this does not change long-term trends that make emerging markets ripe for investment. Volatility and uncertainty are constants, but they also present opportunities.
The US-China trade deal was supposed to settle global trade uncertainty in 2020. Nothing could be further from the truth. Diversified supply chains are vital to minimising VUCA risks into the 2020s.
Market capitalism has survived many rotations of the political cycle over generations. But there is nothing certain or given about capitalism – and today, its future is being called into question, with growing calls to fundamentally change the system.
Coronavirus may well, in time, be seen as the ‘black swan’ event that amplified all the increasing vulnerabilities in the global economic system, as well as accelerating the process of deglobalisation that began in 2016. Each crisis is different and this one is very, very different.
In the decade ahead, ageing demographics, income inequality, market share concentration and climate change will reshape the economy, elevating the VUCA facing investors, requiring deep fundamental research to determine where best to invest.
Elevated demand for safe-haven assets, including government bonds and gold, suggests that investors are anxious. Such fears reflect the current high VUCA - volatility, uncertainty, complexity and ambiguity - market environment which carries many risks, of course. But with those risks come opportunities, too.
Established in 2009, Portfolio Construction Forum Markets Summit is THE investment markets scene setter of the year. This year's theme is "Be alert! High VUCA ahead!" VUCA stands for "volatility, uncertainty, complexity and ambiguity". Markets Summit facilitates debate on the key drivers of and outlook for the markets (on a three- to five-year view) – with particular emphasis on being alert to high VUCA risks and opportunities ahead - to aid your search for return, and to help you build better quality investor portfolios.
Established in 2009, Markets Summit has gained a reputation as THE investment markets scene setter of the year. The jam-packed, one-day, face-to-face and online learning program is designed and curated by our specialist, experienced and independent team and features our Faculty of 25+ leading investment thinkers from around the world. Each offers his/her best high conviction ideas on the key drivers of and outlook for the markets (on a three- to five-year view) – with particular emphasis on being alert to high VUCA risks and opportunities ahead.
Classical economists often incorporated human behaviour into their thinking. But in the 1960s and 1970s, homo economicus - the great rational agent of economic theory - was born. It was not until the 1990s that the link between human behaviour and economics began to be re-established.
Portfolio Construction Forum Strategies Conference facilitates debate on portfolio construction strategies. It will challenge and refresh your portfolio construction thinking by debating contemporary and emerging portfolio construction strategies, to consider applying in practice to build better quality portfolios.
I believe time allows signals to surface amidst the ubiquitous noise. In the spirit of the hit Fleetwood Mac song "Don't Stop" that urges a future focus, I offer this year's set of five-year-forward global predictions.