Written By: Steve Lee
What investment trends have shown consistent, resilient performance and returns over the last 25 years? What will be those of the next 25 years? How will the rise of emerging markets shape the way we look at the world? How do we invest for a better tomorrow and why? Steve Lee, LGPS specialist at Investec Asset Management, talks to capability heads and leaders from across the business about these questions and more
The world has changed profoundly over the past quarter century. Although the fundamentals of investment remain essentially the same, the investment process has become a lot faster. The data revolution has not only speeded up analysis but also transformed the nature of the active manager’s challenge. Managers no longer simply need to find more data and create better intelligence than their competitors, they must see through a surfeit of data to find superior insight.
Our clients have also changed. Today, asset owners are much better informed and more knowledgeable about asset management processes. Their priorities are also changing with the ageing demographics of their stakeholders, who are also demanding more attention to the environmental and social impact of how their savings are invested, and require greater oversight of their investments.
Investment managers are facing several new challenges that will shape the way we allocate capital in the future.
Meeting new challenges
1. Global disruptions
“The last 25 years have been characterised by disruption and crises,” says Russell Silberston, Head of Multi-Asset Absolute Return. “Sterling was ejected from the exchange-rate mechanism in 1992, there was the Asian financial crisis, the Russian crisis, the technology boom and bust, China coming on to the global scene, the global financial crisis and then more recently, Brexit. Markets are uncertain. We cannot quantify what they’re going to do.”
But while there have always been market disruptions, it is also likely that their effects will be wider-reaching. Philip Saunders, Co-Head of Multi-Asset Growth explains that “globalisation has changed the way markets have behaved. Our clients are now international rather than domestic, and allocate capital globally. This means that we have to understand how global dynamics materially impact markets and their investments.”
2. Changes in the markets
Navigating market crises, and helping our clients understand the short- and long-term consequences of these disruptions, is an essential part of investment management. But we are now also facing profound changes to the way the markets work, Philip Saunders explains. “There’s been the growth of high-frequency traders; there’s been a big shift from active to passive managers, accelerated in the recent past by the growth of ETFs and smart beta,” he says. Saunders believes these changes are working against each other in a way that will exacerbate disruption in the future: “markets should be becoming more efficient with increased speed, but they should also be becoming less efficient with the growth of passive investing,” he says. The resulting tension, he believes, “really highlights some key issues for investors to think about in the future.”
3. Sustainable development
To deal with these challenges we have to be more innovative. “The big challenge for the world today can be summarised in two words: sustainable development,” says CEO, Hendrik du Toit. “By the middle of this century, we’ll have 10 billion people on earth. We need to invest in a sustainable way, so there will be significant commercial opportunities in financing not only the infrastructure but also in the businesses and the assets which will cater for that kind of world.”
The way forward
Attention to environmental, social and governance issues
Investing in a sustainable future will be one of the major trends of the coming years. As a firm, we believe that playing a role in financing sustainable development is a central part of our mission of “doing the right thing.” The imperative to invest sustainably was also underlined on a global level in 2015. The Paris Agreement on Climate Change and the United Nations’ Sustainable Development Goals, which were agreed to by the majority of the countries on the planet (even if they are not yet fully ratified), are clarion calls for the world to work together to take action.
This imperative is also driven by our clients. For example, pension funds are aligning their investment practices with the values of their members. As the demographics of retirement savers include larger proportions of individuals from Generation X, Generation Y and even now the Millennials, who care more deeply about social and environmental issues, the vehicles through which they save need to reflect their values. For many pension funds, taking account of sustainability issues is even shaping how they view their fiduciary duty to their members.
The immediate priority is, therefore, that of integrating an analysis of environmental, social and governance (ESG) challenges and risks into the investment process. “We believe it adds more value for our clients if we treat material ESG issues as an integral part of the investment analysis and decision-making process, rather than as a separate consideration,” Philip Saunders says. He is also seeing more clients who require these issues to be included in quarterly report-backs, and a larger number of clients requesting segregated mandates with exclusions and ESG-specific screens.
As we sharpen our focus on ESG and face greater scrutiny from our clients, we believe that when we invest in the equity of companies we should be active shareholders. The Quality team, for example, typically conducts several hundred meetings each year with management teams to ensure they are comfortable with their decision-making processes. Simon Brazier, Co-Head of Quality, explains that “it’s important for us to engage with companies because we’re long-term investors. These meetings not only give us valuable insight into company strategy, but also enable us to make sure that the objectives of the management team are aligned with our aims as a shareholder.”
Additionally, Simon says, meeting with management teams enables his team to make sure that they have the long-term health of their companies at heart. “More than half of what we’re looking for in companies is how they grow their profits and returns,” he says. “Management teams have a corporate responsibility to act in the long-term interest of their company, its shareholders and stakeholders. They shouldn’t focus on short-term pressures like returning cash to shareholders or increasing compensation.”
4. Adapting to changes in emerging markets
“One of the big changes in financial markets has been the emergence of emerging markets into the mainstream,” says Hendrik du Toit. “That process will continue.” Peter Eerdmans, Co-head of Emerging Market Fixed Income agrees, pointing out that these countries change. “It’s almost the definition of emerging markets that they are going through a process of profound change”, he says. We must, therefore, be cognisant of the fact that the countries we think of as emerging today, may not be the emerging markets of tomorrow.
Emerging markets have become more interconnected over time. Simon Brazier notes that, “Emerging markets are becoming an increasingly important part of the investment landscape. I’m a UK equity fund manager, but nearly a third of the revenues of companies that I can invest in come from developing or emerging markets. They may be listed in London, but emerging markets are vital for their growth.” And this holds true for policy making as well as business. “With globalisation, the Fed is even looking at China to impact its monetary policy”, he says, “This is a profound change in the global policy landscape.”
This shift has material consequences for the investment strategies we employ. As countries develop and become higher quality, with stronger monetary and fiscal policies, they start trading more like developed markets. As a result, a static investment process that focuses purely on credit risks, for example, will struggle to outperform on the more developed side of emerging markets.
So what do these challenges tell us about how we should think about investing?
So what do the next 25 years hold? No one has a crystal ball, but we believe that whatever happens it is important that we focus on doing the right thing for our clients, by acting in a way that reflects their values and aspirations as well as our own. We need to make sure that we steward our clients’ money safely and that means adapting to market changes and disruptions. We also have a responsibility to think about the long term and leaving a better future for the savers of today. “Investing is all about tomorrow, not today”, says Hendrik. “So I would argue that investment should be about a better tomorrow and a better future.”
Past performance is not a guide to the future and investments carry a risk of capital loss. Emerging markets may have less developed legal, political, economic and/or other systems. These markets may therefore carry a higher risk of financial loss than those in countries generally regarded as being more developed. The views expressed are those of the contributors at the time of publication and are subject to change.