Buttressing the portfolio for change 

The deglobalisation trend, heightened by the Covid-19 pandemic and amplified further by Russia’s invasion of Ukraine, has disrupted supply chains, caused inflation rates to skyrocket and prompted quantitative tightening by Central Banks.

At the same time, a global transition to greener energy and a move to a net-zero carbon economy in a bid to tackle climate change is creating significant shifts in the world economy.

With so many challenges facing today’s asset owners, it was a pleasure to sit alongside leading investors at Mercer’s Global Investment Forum to hear how they are adapting their portfolios to protect returns and deliver growth.

We heard from Bernard Wee, Assistant Managing Director of the Markets and Investment Group at the Monetary Authority of Singapore; Wey Fook Hou, Chief Investment Officer, Consumer Banking & Wealth Management at DBS Bank in Asia; and Ann Leepile, Chief Executive Officer at Alexander Forbes Investments in South Africa.

Rising inflation

The panellists all agreed that inflation is a corrosive force on their portfolios, with Wee noting there had been nowhere to hide in the short-term, with even traditional sources of inflation protection like inflation-linked bonds and commodities being challenged in the recent period. With commodities, if the intention were to protect against inflation, Wee noted the need to be more deliberate in sector selection, given the variety of return drivers for different commodity sectors.

Hou said that conversations with clients had been “very challenging” over the past eight months, but he had been advising them to stay the course with their investment strategy, arguing that forward looking prospects for simple 60/40 equity/bond portfolios have improved with more reasonable equity valuations and higher bond yields.

Leepile noted that Alexander Forbes had responded to the tailwinds that strong commodity prices were expected to provide for the South African economy by tilting client portfolios away from global equities and towards South African equities. She added that they had “derisked some of [their] portfolios to protect capital and put a lot more allocation into private markets, particularly in terms of infrastructure.”

We similarly noted the inflation-indexed pricing of some infrastructure assets as being beneficial to portfolios in an environment of rising inflation.

Economic decoupling and geopolitical risk

Investors are also increasingly paying attention to the longer-term impact of deglobalisation and geopolitical risks on their portfolios.

In relation to the trend of Western nations moving production back onshore in order to reduce reliance on other countries, Hou suggested that this will result in a major increase in capex expenditure as corporates seek to build new manufacturing facilities in their home countries.

Wee indicated that while he continued to believe in the secular growth story of emerging economies, the deglobalisation trend is likely to slow down the pace of convergence with developed economies. As economies increasingly look inwards and focused on self-sufficiency, Wee also indicated that there is an increasing risk of countries having to bear greater debt burdens going forward, which could be more challenging for emerging economies.

While acknowledging the deglobalisation trend, Leepile said South Africa was unifying with the rest of the African continent through the Africa Free Trade agreement, which she said made it “a lot easier to engage with the East and the West”.

Given that the impact of deglobalisation and that geopolitical considerations could vary significantly from one country to another, there was agreement among the panellists that the traditional construct of allocating to developed vs emerging markets would not be sufficient to reflect the risks and opportunities arising from such variances, and there may be a need to adopt a more granular approach in determining country allocations going forward.

Climate change and sustainability

There is substantial global alignment on the need to address climate change risk, but there is still an enormous amount of work to do to align public and private sector investment with the objective of limiting global warming to 1.5C by 2050.

Wee drew similarities between carbon pricing policies and interest rate policies, arguing that a gradual raising of carbon prices by fiscal authorities – much like a gradual increase of interest rates to deal with inflationary conditions – would mean less volatility. But if governments were forced to hike carbon pricing more aggressively in response to slower than desired progress on climate objectives, then investors are in for a bumpy ride.

“That’s a factor that investors need to think about and understand the risks,” Wee said.

At DBS Bank, Hou said environmental, social and governance (ESG) factors are firmly integrated into investment strategy.

He said: “When the fundamentals and valuations are equal between two companies, but one has a higher a higher ESG rating, we will invest with that company.”

Panellists also discussed the dominance of environmental factors in ESG discussions, and Leepile called for a greater appreciation of the ‘S’ and the ‘G’.

“There are immediate crises in the world that also need addressing outside of climate. South Africa sits with a 34% unemployment rate, and we have a heavy resource-based economy. Should we opt to disinvest from a number of what you would call polluters in the world when that might increase the unemployment rate creating huge political instability and risks for us as a country?”

Instead Leepile favours impact investing which, she said, encourages companies to deliver the type of world in which “we all want to work and live”.