How can investors meet their objectives in an investment environment characterised by greater uncertainty, volatility and low returns? What are the major questions that we need to consider to put money to work to create a better tomorrow? Hendrik du Toit, Investec Asset Management’s chief executive officer, suggests that we should challenge current investment orthodoxy.
Will humanity end poverty and our destructive impact on the natural environmental in the twenty-first century, while maintaining peace? These are the big challenges of our generation. We have the potential to harness the power of our multipolar, multicultural and interconnected world to establish a platform for the sustainable development for the planet and its people. Why then refer to an “age of uncertainty”? This relates the serious doubts about our collective ability to implement our good intentions fast enough. To achieve sustainable development over the long term, we need to deal with the current political and productivity dilemmas facing our world.
On the positive side, the world has taken significant steps towards this goal in 2015. The United Nations’ 2030 Development Agenda, including the 17 Sustainable Development Goals, and the Paris Agreement on Climate Change have created a universally accepted global policy framework for a new economic paradigm. 2015 was also the year in which the sustainability agenda went mainstream, with many major institutions adopting stronger environmental, social and governance criteria.
But for all the good intentions, achieving these aims still seems a long way off. Seven years after the financial crisis, the global economy remains fragile. Consequently, markets are volatile, global economic growth is weak and productivity is going nowhere.
So how can we, as owners and stewards of capital, help mitigate this cycle of volatility and stagnation? I believe that we should challenge current investment orthodoxy and ask whether it remains fit for purpose. We need to protect the savings of the pensioners of today and tomorrow, so they have confidence that they will have a dignified old age. We need to preserve and grow wealth for future generations. We need to lengthen our investment horizons beyond the next quarter. We need to channel long-term capital to the opportunities that will drive future economic growth and productivity.
“As uncertainty abounds asset allocators must embrace risk and seek appropriate rewards for doing so.”
The age of the “risk-free asset” is over. In fact, more than $10 trillion of risk-free assets guarantee eventual capital loss explicitly via negative yields! Most of the remaining pool of risk-free assets is destined to lose investors vast amounts of capital if we assume the eventual normalisation of interest rates. Before the financial crisis, when US Treasury bills were yielding 5% or more annually, institutions could easily meet their mandated returns by taking little risk. But we no longer live in that world. Interest rates have been at historic lows for the best part of a decade and now several major central banks have adopted negative interest rates, an unthought-of situation until recently. Global economic conditions are unlikely to be conducive to rate hikes any time soon. Institutions will, therefore, have to take on more risk to meet their return objectives. It’s not just a question of more risk, however. To build a portfolio that meets its stakeholders’ requirements, it’s a question of which and how.
The risk of an unwillingness to take risk should be firmly on the investment agenda. Understanding risk in the context of record low bond yields and finding genuinely diverse risk exposure and return opportunities. This is a huge challenge for the investment world.
If they are to take on more risks, institutional investors must understand the nature of those risks better and know when they will be rewarded appropriately. This imperative is driving one of the most important transformations of our industry: the stronger relationships between asset owners and asset managers. The combined resources could be used far better if we see our supply chain as a long-term partnership for the benefit of savers and the community.
If the parties along the investment value chain can engage and pull in the same direction, it becomes easier to generate long-term value for all concerned. This process may eventually mean that portfolio managers can try to move beyond the quarterly reporting cycle and mark-to-market valuations that drive chronic short-termism and stymies long-term investing. The challenge is knowing what that engagement looks like, how it complies with regulatory requirements, and how to structure the reporting process. The question is obvious but the correct answers elusive.
“As institutions become more savvy and demanding, they are looking for partners with similar interests that can share their knowledge and experience.”
The challenge for all investors, however, is persuading stakeholders that the way we save has to change, including the way our industry operates. If we continue to allocate in the same way, we will fail the ultimate owners of our capital: the working people of the world, who save for their retirement while funding a better tomorrow for their children. Not only will we fail to provide for their needs, but this period of uncertainty, volatility, of low growth and productivity will be prolonged. Such a move requires our boards and trustees to take a longer-term view of their stewardship of the capital and think about what that means for their portfolio strategy.
As part of the effort to encourage investors think about longer-term outcomes of their investments, in January 2016, I joined the Business and Sustainable Development Commission, founded by Paul Polman the CEO of Unilever and former UN Secretary General Lord Mark Malloch-Brown. It is important that the investment industry plays an active role in shaping the debate around how business can take practical, commercially viable steps to help achieve the Sustainable Development Goals.
I hope that the Commission will be able to make progress towards scoping out the instruments that can finance a new global economy based on resource-saving technology, carbon-neutral infrastructure, IT and communications. This paradigm should drive growth, employment and complement the skills and interests of people across the world.
Part of the Commission’s mandate is to help businesses around the world understand the role they can play in creating this new reality. Over the next 12 months the Investment Institute Journal will tackle the theme of resilience in the age of uncertainty, as part of our contribution to this debate. The Journal will draw on our capabilities as an asset manager, the experience of investors and the analysis of leading economics and policy experts to help investors understand how they can put their capital to work to generate long-term returns for the benefit of future generations. Investec Asset Management hopes that this contribution will help our clients plot a course through this challenging and rapidly developing economic environment.