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Our Markets Summit program kicks off with a video retrospective of the key events of the prior year...

The herculean tug of war between stronger economic growth and higher bond yields will be the defining battleground of 2021 and will be accompanied by violent and rapid-fire recalibrations of relative valuations.

Jonathan Pain | 0.50 CE

Our diverse panel of experts debates which of the high-conviction propositions they heard during Markets Summit 2021 resonated most strongly, and which they disagreed with most - and the portfolio construction implications.

Supply chain decision makers must continue to focus on mitigating risk in 2021, not maximising growth. Logistics disruptions, competition for components and viral mutations overshadow the first half. Further ahead, political risks outbalance opportunities as China flexes its power in Asia, the Biden administration applies what still amounts to an America-first approach, carbon- and digital-taxes abound and new trade deals lead to stronger competition across manufacturing industries.

The energy transition has the potential to be as transformative for the world economy and geopolitical landscape as the digital revolution has been since the 1980s. Shifting from energy derived from fossil fuels to renewables opens up tremendous direct and indirect growth opportunities for investors. There will be increased focus on green bonds and low carbon equities. However, the implications of the energy transition go beyond that. There will be new growth opportunities as many parts of the world economy have the potential to shift from being fossil fuel poor to renewables rich. Standing on the verge of a new decade of transition, it’s time for investors to go back to the drawing board and embrace sustainability, not just in stock selection, risk management or asset allocation, but in every facet of their thinking.

As investors go ‘back to the drawing board’ amidst a changeable market outlook for 2021, private equity is an asset class to access now due to its bias for long duration assets with attractive growth profiles. As structural tailwinds for technology continue to accelerate, there is a dearth of listed options for Australian investors to hold; in contrast, private equity offers exposure to businesses with quality recurring revenues at discounts to listed peers. Often underrepresented in investor portfolios due to concerns around liquidity, private equity investing with a truly hands-on approach allows active investors to maximise their capital growth potential.

March 2020 saw extreme intra-month volatility across all markets. Daily liquid funds exacerbated this volatility and failed to provide the liquidity promised to investors. In the subsequent recovery, these same funds are singularly focussed on truly daily liquid investments at the expense of returns. Rather than accepting lower returns for liquidity, investors should go back to the drawing board and re-assess their need for daily liquidity. In this low yield environment, there is a role for non-daily liquid strategies which allow investors to buy when liquid funds are selling, to invest outside of the shrinking universe of highly liquid investments and, ultimately, achieve consistent excess returns.

After a decade of falling inflation and interest rates, investors must now go back to the drawing board as we look to a very different world in prospect. The aftermath of the GFC saw a series of discrete factors which crippled growth: fiscal austerity; EU intransigence; Chinese tightening and reform…then a global trade war and a global pandemic! The world has changed. Yet investors appear anchored to a narrative about growth and inflation that will prove supremely unhelpful as the global economy reopens amid vaccine distribution, sees the effective cessation of the “US-versus everyone” trade war and widespread, colossal, redistributive fiscal policy. Those who cling to yesterday’s narrative may forego one of the great trades of recent decades as the world shifts to a “global reopening” narrative and away from that of “secular stagnation”.

Fiscal stimulus and the vaccine have fuelled an extraordinary rally in equities but ultimately stocks are at record highs because of extraordinarily low market interest rates. This means that for investors, the decision between cash and equities or between sectors hinges on the rates outlook. Even though there are forces keeping rates low, it would be complacent to assume away the risks of higher rates because the inflation outlook is more uncertain than usual at the moment. It would be back to the drawing board for investors if inflation pressures structurally rise, because the Federal Reserve put will be kaput and portfolios would need a radical overhaul. Investors should be wary of inflation – but also of being underweight equities.

With the official cash rate near zero, generating income from traditional fixed income investments is challenging. The low-rate environment and prolonged equity bull run pre-Covid drove many investors to overweight growth assets. However, the market volatility of 2020 highlighted the risks of this approach. It’s time to head back to the drawing board to find a more consistent source of income. Private Debt is a lesser-known sub sector of the fixed income market that has delivered attractive yields with high capital stability through market cycles. Debt ranks ahead of equity in a company’s capital structure, resulting in much-needed downside protection. With less volatility than equities, and low correlation to public markets, private debt provides a compelling alternative source of income in a portfolio.

Investors should reevaluate the role of bonds in a traditional 60/40 balanced portfolio. With today’s very low yields likely to persist, the 60/40 balanced portfolio needs to be “stretched” or redesigned, in order to mitigate the impact of low yields on overall portfolio risk and return. Investors need to make their equity allocation work harder through active management and consider new diversifiers such as long duration bonds or alternatives.

Pockets of froth in markets drive the narrative of an equity market top. However, the equity market in aggregate is not as concerning. Equities are underpinned by unprecedented fiscal and monetary policy – aimed at righting previous wrongs - coupled with economic re-opening. Earnings growth should result, amid abundant market liquidity, in a zero rate world. Markets remain supported – but divergence could increase within. Covid-accelerated trends include digitalisation, geopolitical tension and the impact of ESG on the cost of capital. These trends are structural and investors waiting for reversion to mean should beware. Going back to the drawing board, portfolio construction along with industry understanding remain the bedrock of investment success.

The resource sector is structured around cycle, earnings, capex and returns, but long- and short-term sentiment could be the real drivers. Commodity prices, capex and returns are not yet at peak cycle. De-carbonisation, company management and ESG scrutiny are all emerging themes, diminishing the favoured influence of commodity prices on sector alpha generation. Is this an evolution of value drivers for the resource sector, or are investors just a little late to the drawing board? If long term sentiment begins to turn, then there is significantly more value to be found in the resources sector.

The consensus view that US equities are in a bubble are overblown due to several dynamics: index composition; low interest rates; robust forward earnings expectations; and, economic cycle positioning. The biggest obstacle with current market expectations is a double-dip recession which remains a remote possibility based on the positive output of 12 economic indicators that have historically foreshadowed an economic downturn. In fact, economic growth in the US this year is posed to be the best in almost four decades as US consumers and corporations have fortified their balance sheets in the wake of recent lockdowns. Policymakers are suffering from recency bias by mistakenly treating this recovery like the Global Financial Crisis. However, the backdrops between the two could not be more different which sets up a scenario where US equites will continue their ascent higher in the coming year. Go back to the drawing board when it comes to your views on US valuations - because this time IS different.

Pent up consumer demand, fiscal stimulus and accommodative monetary policy set the stage for a sharp global recovery. It is back to the drawing board in a high growth environment.

Ronald Temple | 1 comment | 0.50 CE

Established in 2009, Portfolio Construction Forum Markets Summit is THE investment markets scene setter of the year. The geopolitical, macroeconomic and corporate outlook remains unclear, yet stock markets continue to climb this wall of worry. It is time to pause, reflect and go back to the drawing board! Markets Summit will help you better understand the key drivers of and outlook for the markets (geopolitical, economic and asset class), and the opportunities and risks ahead, on a three- to five-year view, to aid your search for return and to help you build better quality investor portfolios.

Investors cannot afford to be “lazy” and leave investable capital sitting idle. Expanding the investable universe can help meet the need for positive real returns while maintaining an appropriate level of insurance in portfolios. Going back to the drawing board, it is time to look closely at the illiquidity premium – the one risk premium that offers strong value over the cyclical horizon. A combination of interest rate, credit and illiquidity risks provide diversified fixed income exposures with attractive return potential.

Structural factors are in place which will ensure that the cash rate cannot rise over the medium term. This will result in negligible cash returns over the foreseeable future, with only mild defensive properties. What is the best alternative in the defensive bucket? Going back to the drawing board, a core fixed income exposure consisting of Australian government bonds will outperform cash over the long term.

The Covid-19 pandemic has accelerated profound shifts in how economies and societies operate and is transforming macroeconomic policy, geopolitics and sustainability. The traditional business cycle playbook does not apply to the pandemic and as this new investment order evolves, investors are returning to the drawing board to identify the key drivers of change. Portfolios must now reflect the new role of developed market bonds given falls in real yields, the realities of an increasingly bipolar US-China world order and the growing investor appetite for sustainable assets.

After being considered a cottage industry for nearly four decades and now increasingly demanded by investors across developed markets, Responsible Investing (RI) and the application of Environmental, Social and Governance (ESG) factors into the investment process remain misunderstood – and, too often, mischaracterised as style over financial “substance”. Secular, societal and increasingly standardised drivers behind the systemic adoption of RI across all asset classes – along with the ascendancy of shareholder alignment as a growing movement – is clearly evidenced through three issues: 1. the democratisation and development of data in financial markets; 2. ESG integration has been demonstrated to have a positive impact on portfolios; and, 3. the push for passive which misses the point that beyond lack of sovereignty, there is a collective responsibility to align portfolios with client values. It’s time to go back to the drawing board (for many) and construct portfolios with investment strategies designed to advance humankind towards a global sustainable economy, a just society, and a better world.