Update Magazin II/2019 Download the complete magazine

1 Sustainability is a factor no investor can ignore

The Forum’s opening sessions concentrated on climate change as part of a broader discussion of sustainable investing, that reflects investors’ increasing focus on this area. After nearly two decades managing sustainabilityfocused portfolios, we have demonstrated to our clients that environmental, social and governance (ESG) factors can help improve risk/reward profiles. This is an important reason why sustainability has become a core consideration for many investors, particularly large institutions. Looking ahead, investors will increasingly focus on how they can deliver real-world impact through the way they invest.

The urgency surrounding climate change in particular has focused more investors on sustainability. Increasingly, businesses will need to factor in climate-related regulations – there are nearly 1,500 policies and laws related to climate change in effect worldwide – and public scrutiny will arguably exert even greater pressure. The goal of many of these regulations is both to influence companies to change their behaviour, and to persuade investors to direct capital in ways that have a positive real-world impact. Regardless of investors’ personal views on climate change, any company that operates globally will inevitably face increased scrutiny on this issue.

Moreover, sustainable investing is about more than climate change: it helps to improve corporate governance, and make business models more sustainable. Through our integrated ESG approach, we gain a deeper understanding of the risks that could affect a company’s performance throughout its value chain. And we’re able to work with companies that may have low ESG ratings to improve their standing and, consequently, their return potential. Indeed, as an active investor, engaging with boards and management teams to set clear targets and improve governance is integral to our value proposition.

We have also seen rising awareness from clients looking for impact investments – combining attractive return potential with a specific social or environmental benefit – especially from the younger generations who will become increasingly powerful investors (seeChart A/).

A/ Major growth expected in impact investing

Source: AllianzGI, Hub investment estimates; GIIN Annual Investor Survey 2018

2 Taking risk is still essential – but make smart choices

While the global economy continues to muddle through its late-cycle stage, bouts of market volatility have unnerved many investors and, seemingly, the US Federal Reserve (Fed). To stimulate growth and inflation, central banks globally are keeping interest rates lower for longer, with the prospect of near-term rate cuts now priced in in the US. While this monetary policy stimulus is likely to support asset prices in the long run – making any setback in risk assets a potential buying opportunity – it is important to take valuations into account.

The low-rate environment has the knock-on effect of suppressing the yields of government bonds, but it hasn’t deterred investors. In fact, Bloomberg recently estimated that investors own nearly USD 10 trillion in negative-yielding bonds. Some investors are so risk-averse that they willingly let their portfolios steadily lose value in “safe” investments and fail to protect the purchasing power of their savings.

One of the factors making investors nervous is the state of global trade and the prospect of trade war. US President Donald Trump has met with some success in using tariffs as a negotiating tactic – although, in the case of China, his efforts have met with sufficiently little movement that we now put the odds of a favourable trade deal at just around 50/50. Chinese President Xi Jinping has too much at stake with the “Made in China 2025” plan – designed to move Chinese manufacturing into value-added areas such as technology and clean energy – to let the US get its way. In addition, even if Mr Trump’s focus is currently on China, investors should not rule out the prospect of him imposing tariffs on Europe and other traditional US allies.

With elections coming up in 2020, and the increasing likelihood of a US recession that year, Mr Trump will look for other ways to motivate his core supporters – more proof that investors everywhere should watch political risk. Still, we are convinced that it would be a mistake – if not outright impossible – for investors to avoid risk altogether. Investors must take some risk in order to earn a reasonable return, but they should be selective and manage risk actively – using fundamental research to make insight-driven decisions and incorporate ESG factors.

3 Diversify to achieve returns in a slow-growth, low-yield global economy

Despite the late-cycle backdrop, opportunities exist for investors. US equities have done well recently (see Chart B/), with major indices posting double-digit returns this year following a rough fourth quarter of 2018 – but this may be an unsustainable growth rate. Our research indicates that US equity and bond markets are likely to produce lower returns and be less correlated in the next 10 years. Furthermore, non-US bonds are also likely to generate low returns while non-US equity returns are set to hover around the levels experienced over the very long term. Adding alpha to beta is key – especially as beta returns are set to be lower and more volatile. And, given the more muted return outlook, investors may want to reconsider their overall asset allocation in light of their long-term objectives.

Where should investors turn? Here are some ideas:

Alternative Investments have the potential to improve investment performance and risk profiles. Liquid alternatives are a good diversifier given their historically low correlations with equities and bonds. Illiquid alternatives can offer a potentially interesting extra return – the illiquidity premium – in times of low interest rates, and we are seeing significant investor interest in infrastructure equity/debt and private equity/debt. As active asset managers, we play a role in helping guide investors on how alternatives can help them meet their investment objectives, particularly as the available universe of alternative assets expands.

Income-generating investments are designed to provide a range of benefits to portfolios – from more stable, predictable returns to a lower risk profile. Attractive income potential can be found in a range of “riskier” assets. Consider dividendpaying equities, higher-quality high-yield bonds (particularly in the US and Asia) and emerging-market debt. Longerduration assets may also be a smart choice in the near term, given their ability to hedge equity-market volatility.

Differentiation between regions and sectors is increasingly important. As the interest-rate cycle peaks and concerns grow around the global economy and trade tensions, valuations become a more critical metric. On this basis, we see attractive opportunities in European, emerging-market and Asian equities. Furthermore, equity income may be more powerful than equity earnings growth for the next few years.

Europe has been unloved by investors for some time, but we see strong potential there, particularly with the European Central Bank committed to keeping the economy moving. The relative dearth of leading global tech firms domiciled in Europe does not equate to a lack of investor growth opportunity – Europe has a strong line-up of leaders in product and service innovation, and a record of start-up successes in the technology sector. The region could, however, benefit from deeper capital markets and more fiscal stimulus at the national level. Investors should of course be aware of how the EU may be caught in the crossfire of the trade wars and new US-China “tech cold war”, but Europe could also be one of the winners from the ensuing disruption to value chains.

Market timing may also be an option for active investors. In a volatile yet sideways-trending market, the strategy can offer an additional source of return potential.

B/ US equities look expensive based on historic norms
Shiller-PE S&P (Price/10-Year earnings average): current level at 29.8

At a CAPE of 29.8, the S&P 500 trades ~1.88 standard deviations above the historic norm. Past performance is no guarantee of future results.
Source: AllianzGI, Robert Shiller, as at May 2019.

4 Be active and countercyclical to help seize opportunities

We expect any number of forces – from central-bank actions to political uncertainty to classic mean-reversion – to generate more market volatility. Prior tailwinds may turn into headwinds as price-to-earnings ratios peak and low interest rates squeeze future returns. Investors may hold “safe”, low-returning assets or consensual long US assets because they felt they had little choice, but in fact they have many options.

This is a compelling reason for investors to consider an active asset-management approach when setting the optimal “risk mix” within a portfolio – particularly since passive investments participate fully in every market decline as they track their underlying indices. Procyclicality – the tendency to follow the herd or track the cycle – is potentially one of the biggest destroyers of value. Yet good active managers have in-depth knowledge of companies, industries and markets that can help them seek out the above-market returns and understand where future potential performance lies.

Much of active managers’ knowledge is derived from fundamental research, which can be particularly helpful when markets are turbulent. Consider the value of proprietary research into a company’s supply chain during a time of trade disputes and geopolitical tensions: it can help investors seek out the winners while aiming to avoid the losers. Research can also help investors set more reasonable long-term return expectations, and pay the right price for the right investment.

This last point is an important one, because today’s markets have an upside as well as a downside. That’s why it’s critical for investors to be opportunistic while looking far enough ahead: with a long enough time horizon and an active approach, they are more strongly positioned to weather all kinds of market environments.

Investing involves risk. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on management‘s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. We assume no obligation to update any forward-looking statement. The value of an investment and the income from it may fall as well as rise and investors may not get back the full amount invested. There is no guarantee that the strategy will succeed and losses cannot be ruled out. Investors may not get back the full amount invested.

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