Déjà New: How hindsight and foresight can help investors manage risks 

At our recent Global Investment Forum in London, we discussed the concept of ‘Déjà New – from Hindsight to Foresight’ which we set out in our outlook paper about 2023 themes and opportunities. But what does it mean?

Rising interest rates, stubbornly high inflation, and renewed cold war tensions, leave us with a sense of déjà vu. In other decades, particularly the 1970s, investors also had to deal with many of these challenges. Even though we now are seeing echoes of the past, we are not in the same place.

Distinct parallels can be drawn between decades, and when combined with the potential for change, this is what we call ‘Déjà New’. We believe themes that reflect the lessons from the past combined with foresight can give investors the best chance of long-term success.

Economic crises of the past can provide us with a toolkit to help us manage opportunities and risks – but no event is the same as the last one. 

Rich Nuzum, Executive Director, Investments at Mercer, told delegates at the Global Investment Forum that extraordinary market events, while unusual, will regularly occur – providing opportunities for investors who have planned for crises. 

"Fat tails" where extraordinary anomalies wildly affect the average performance of a market can be seen in the Asian Financial Crisis, the dotcom bubble, the crash of "87". The 2008 Global Financial Crisis and the COVID pandemic, or the recent Gilts crisis – all somewhere between seven and 20 standard deviation events. 

While it is tempting to pay attention to the mean and the most likely economic scenario, Nuzum said we should expect fat tails, noting how "client-after-client" is trying to figure out ahead of time who's going to take which decisions during an extraordinary event. “That work to improve governance could pay off even if the next crisis is completely different to the previous ones.”

The recent emergence of systemic risks in the banking sector following the collapse of Silicon Valley Bank has raised concerns of a renewed financial crisis, as the impact of higher interest rates work their way through the commercial real estate and housing markets, and through business models in a wide variety of industries that relied on cheap capital. 

A huge difference between now and the past is that we are facing a much wider sustainability crisis with severe physical damages from climate change and risks to biodiversity. Even that has echoes with the 1970s, which saw its own environmental challenges (including acid rain and a growing hole in the ozone layer) and a stagflationary shock from rising energy prices.

While it is often impossible to predict fat tails, investors can revisit their governance structures to ensure they are ready to react in an appropriate and timely way to these events when they happen. 

Asset owners or fiduciaries could look at rebalancing discipline and managing around triggers for target-date glidepaths in defined contribution schemes, for example. 

Whether you are an opportunistic investor seeking more upside or just want to be better prepared for risks and shocks, the ability to be reactive during those crucial times will be important. 

Nuzum said it is vital that your governance structure allows you to be more agile when responding to market events. For example, having a good oversight of your managers and a clear view of your positions.

While it remains to be seen how the various challenges will play out, investors must follow through on their principles. Investors will need to find ways to make their portfolio more robust while still generating performance. For example, they should adopt a best approach to diversification to meet their risk/return goals.

James Brundrett, UK Head of Intellectual Capital at Mercer said: "Investors are asking how they can make their portfolio robust as well as still getting performance and returns through opportunities in the current environment – whether that be low-risk returns or looking at the high-risk return end of the spectrum in the public and private markets."

Investors also need to focus on how to deal with the risks posed by the modern crisis of climate change. The transition towards a more sustainable world will give rise to potential investment risks as well as opportunities for investors. 

We think energy transition funds may benefit from shifts in demand and regulatory tailwinds, and environmental funds could provide some opportunities. But it may also be important to engage with mining companies that will play a vital role in the energy transition, for example.

Annabell Siem Mathiesen, Global Head of Sustainable Investment at Mercer, noted that open communication and involvement between different stakeholders will help avoid impasse, as more organisations explore the impact sustainability agendas may have on their own activities. 

"To help secure attractive returns and manage risks, it is important to have the right level of data and transparency on your investments as well as engagement with companies," she said. "More clients are also integrating ESG across their whole portfolio rather than selecting just a few ESG strategies, and we expect this to increase going forward."

Faced with a new world that has some echoes of the past but looks different, we think investors should consider ramping up their focus on governance and ESG integration to turn challenges into opportunities.