Central banks and super-computers will do less of the heavy lifting
The last decade has seen unprecedented levels of central bank intervention as countries have attempted to fend off the effects of the global financial crisis. Despite speculation that another global recession may be on the horizon, asset purchase programmes in the US, UK, Europe and Japan have largely served their purpose.
However, the withdrawal of quantitative easing (QE) will require investors to adopt new approaches, say fund managers. “What worked for investors in the era of QE probably won’t work for them in the era of quantitative tightening (QT),” says Alex Gunz, manager of Heptagon Capital’s Future Trends Global Equity Fund. “QE kept many companies afloat that may otherwise have gone bankrupt.”
But while the Fed and Bank of England were tightening monetary policy at the end of 2018, China and the European Central Bank were still continuing to do the opposite; a divergence that Thanos Papasavvas, founder and chief investment officer at ABP Invest, believes will benefit investors who are well prepared.
“It’s not simply that central banks are no longer spoon-feeding investors, they are no longer singing from the same hymn sheet,” he says. “Asset allocation will need to become more tactical and currency analysis will become more important as central banks diverge. The way for investors to play this is to be active rather than passive.”
Passive investments such as exchange- traded funds have surged in popularity over the last decade, largely because they are cheaper than active managers, some of whom have been under-performing in choppy markets.
Artificial intelligence programmes formulate trading strategies based on historical patterns, but some predict that their role will diminish as QE unwinds. The big problem with passive investing, say James Beck, a portfolio manager at James Hambro & Partners, is that “investors own every company in an index, good and bad”.
“Investors will increasingly need to do more than just ‘buy the index’,” says Maurice Gravier, chief investment officer for wealth management at Emirates NBD. “Your competitive advantage will come from a combination of active management and adopting contrarian positions. Volatility can become your friend – provided you do your homework.”
A catastrophe bond is one way to diversify in the face of stock market volatility. In return for sharing the risk of loss from events such as hurricanes, holders receive an annual insurance premium. “The key point is that these risk events are unlikely to occur at the same time as stock market crashes,” says Andrew Milligan, head of global strategy at Aberdeen Standard.
Geopolitics will become even more important.
The hunt for higher returns will produce more winners and losers
A hunt for yield that began in an era of low interest rates will continue as central banks hike rates cautiously and asset prices rise more slowly as QE is withdrawn.
Given how far the US is along the path towards rate normalisation, holding US debt and dollars will become more attractive, says James Beck. “Cash is becoming an asset class in its own right again and US treasuries have become a real return asset again for the first time in a decade.”
However, the pitfalls for yield-hungry investors could multiply, Mr Beck warns. “A lot of discipline has been lost since QE began as people desperately sought yield. The result could be a car crash somewhere, possibly linked to emerging market or corporate bonds. A lot of people were just happy to get a return without understanding what was under the bonnet.”
Investors must avoid putting all emerging markets into one basket, says David Storm, head of multi-asset portfolio strategy at RBC Wealth Management, who believes good value can be found following stock market declines in emerging markets at the end of 2018.
“The yield spread between emerging market debt issued in dollars and US corporate debt looks attractive,” he says. Thomas Becket, chief investment officer at Psigma, agrees. “Asian equities look attractive on a long-term view. Valuations have reset and complacency in those markets has reversed to quite a degree.”
Infrastructure is another area of interest, says Mr Storm. “A 6% yield for a global infrastructure fund is compelling. Demand will be underpinned by the trend for urbanisation as countries upgrade roads, power grids and switch to solar.”
“The hunt for higher yields will take investors outside the mainstream,” says Andrew Milligan, who sees diversification as crucial. He believes that tighter banking regulations post-crisis have created opportunities to replace banks. Examples of higher-yielding income streams include litigation finance, commercial real estate debt, healthcare royalties and asset-backed securities.
The UN says two thirds of people will be living in cities by 2050, putting a strain on existing infrastructure. India has the fastest population growth in the world and will become the most populous country on earth by 2022. Nigeria will overtake the US and move into third place after China by 2050.
The ageing global population is good news for companies invested in healthcare and medical devices like hearing aids and orthopaedics. And those medical devices are getting smarter.
Geopolitics will become even more important
Investors should be firmly focused on China, according to Savvas Savouri, chief economist at Toscafund. “China only began to develop properly in 2002, so it turns 17 this year,” he says. “What do teenagers need? Education.
It’s almost as if they can’t build the student accommodation quickly enough in the UK to cope with demand. “Australia, Canada and New Zealand are three other economies set to benefit from China’s economic growth and the associated demand for commodities. They are first world countries with no problems around ownership of natural resources.”
Trade tensions have produced a battle of wills between the US and China, one which Thanos Papasavvas believes China would win – although economic pragmatism should keep any escalation in check, he says.
“President Trump needs to ensure trade frictions are not too aggressive ahead of the 2020 election. The Chinese administration can think longer term and there are many levers they can pull to control their own economy.” Andrew Milligan agrees that investors will need to keep a close eye on US-China relations. “Who will prevail?
Is it worth a longer-term switch from the US to China? How hawkish are the speeches from the US establishment, and how high are defence spending levels? These are questions investors need to ask before allocating their money.”
For Maurice Gravier, the most serious geopolitical risk is the rise of populism. “The level of public debt in Europe means governments don’t have the leeway to find a response to middle-class anger”, he says.
Mr Papasavvas believes that if governments do loosen the purse strings, it will create inflationary pressures, which make consumer-facing stocks and real estate good bets for investors. But the bigger concern is the departure of Angela Merkel because of her role in holding the EU together, he says.
“Political uncertainty means government bond yields could rise. Where? In a less closely-knit Europe, investors will need to look at the component parts and perform a credit analysis on each country.”
Elsewhere in the world, Mr Savouri believes Chinese self-interest will lead to a détente between North and South Korea, which he says may give South Korean stocks a competitive advantage over their Japanese counterparts.
There will be some beneficiaries if trade tensions between the US and China persist. The countries where exporters to the US stand to benefit include Mexico, Canada, Vietnam, Bangladesh and Germany.
Vietnam could benefit from US/China trade tensions
Ethical investing will give you more than a warm glow
The ethical arguments around carbon, tobacco, plastics and the sustainability of natural resources have grown louder in recent years. While this has heaped regulatory pressures on some industries, it has also driven the rise of so-called environmental, social and governance (ESG) investing.
“Nine out of ten of our younger investors want to know where they are invested, which didn’t happen with the previous generation,” says James Beck. “The good news is that this desire has coincided with a period when it has become more profitable. There has been a convergence of conscience and wallet over the last decade.”
Social media has helped to drive the trend, says Ben Goldsmith, CEO of Menhaden Capital, an investment company with an ESG focus. “The world has become a much more transparent place. It’s not just consumer-facing companies that are exposed to this risk but also their suppliers,” he says.
George Latham is chief executive of WHEB, an equity investor focused on “opportunities created by the transition to a low carbon and sustainable global economy”.
“The point for investors is not to look at companies that are less bad than their competitors,” he says. “Focusing on the subset of companies actively contributing to solutions is how you protect yourself. Resource efficiency is one particularly attractive area. In the energy, material, industrial and IT sectors, there is a whole range of different ways to improve and cut waste.”
The potential danger for investors is that they find themselves jumping on a bandwagon, he says. “There is a risk around company valuations when you are exposed to growth markets and it’s an area we need to be disciplined about.”
However, Savvas Savouri believes a move towards ethical investing could inadvertently push capital into legally grey areas such as predatory lending, as the returns on offer prove too tempting to resist. Others believe it could boost demand for what in the future will be seen as fringe activities, for example petrol-fuelled cars once the switch to electric becomes more widespread.
Demographic changes as well as regulation will also present opportunities for investors, says David Tosh, a director at RBC Wealth Management International. “The ageing global population is good news for companies invested in healthcare and medical devices such as hearing aids and orthopaedics. And those medical devices are getting smarter.”
The percentage of people with diabetes rose to 8.5% in 2014 from 4.7% in 1980. As the global economic burden of diabetes continues to escalate, demand for medication will grow. Regulation may tighten as governments take preventive measures, such as promoting exercise and discouraging the consumption of sugary and fatty foods.
Opportunities and risks for tech investors will become starker
The tech-heavy NASDAQ composite index grew 82% in the four years to September 2018. In the final quarter of the year it fell by 18% as investors became jittery that a decade-old bull market may have been coming to an end.
The initial rise was exacerbated by “the herd mentality” of passive investing, says Alex Gunz. “Beware of acronyms,” says Savvas Savouri referring to the so-called FAANG group of stocks that comprises Facebook, Amazon, Apple, Netflix and Google. “These stocks are not homogeneous.
The key question investors need to ask when looking at the tech sector is whether something is supplantable. Amazon has spent 25 years developing its footprint so it can’t be supplanted by a rival. Google has an algorithm. Whereas I can guarantee you that kids born today won’t be using certain social media sites when they grow up.”
Thomas Becket says that a reversion in stock valuations that became detached from reality may continue as investors refine their thinking. “The days of buying any tech company with AI or blockchain in its name are now largely behind us.”
“The theory is that people overestimate the impact of tech in the short term but underestimate it in the long term,” says Mr Gunz. “Investors need to think clearly about the long term opportunities. Will the amount of data produced and consumed grow in the next ten years? Yes. Will there be more automation in factories? Yes.
Will there be changes to the way DNA is analysed and illnesses diagnosed from new tech? Yes.” Investors also need to be aware of the disintermediation threat posed by tech, says William van Straubenzee, deputy chairman at James Hambro & Partners.
“We are invested in DS Smith, the box maker for Amazon, travel food experts SSP and property company Shaftesbury, a major beneficiary of Crossrail footfall. These are companies that aren’t going to get a knock on the door from a tech giant. How is Amazon going to kill a bug better than Rentokil?”
Investors seeking to tap into the huge potential of the Internet of Things (think about the proliferating number of interconnected smart devices in your home and office) may find that there is more upside to buying dedicated semi-conductor makers or 5G network specialists than in the broader tech