In its latest position paper, the Australian’s Future Fund describes its approach to investing in a new investment landscape characterized by the end of 60:40 portfolios, inflation, declining corporate profits and climate change, among others.
Australian’s Future Fund, the $ 245.8 sovereign wealth fund, plans to increase its structural risk profile slightly to better target its 10-year benchmark of 6.1% desired returns while continuing to moderate risk appropriately. During the year until June 30, he raised his risk profile and this will continue [See Future Fund adds risk and generates best ever return.]
In its latest position paper, the fund also details plans to develop its models and governance to better combine its long-term investment strategy with the ability to evolve flexibly. Elsewhere, the fund notes an increased tolerance for illiquidity given the current investment environment favoring skill-based returns that are worth the higher fees.
The plan is also to apply additional resources to identify and pursue high conviction value-added exposures, particularly in private markets and debt. Private markets offer inflation protection and defensive characteristics, but the fund also sees public markets add value through strategies that tightly manage the use and costs of illiquidity.
Future Fund’s latest analysis of its approach to investing is a consequence of significant changes catalyzed and accelerated by COVID-19 that are creating a new order of investing. Expect lower returns, more inflation risk, more divergences, conflict and market fragility, the fund says. The current investment environment will also test long-held assumptions and challenge the conventional wisdom that has guided the fund since its inception in 2006.
“We believe that the investment thinking that has generated strong returns over the past decades needs to be reconsidered,” the fund writes. “We believe that preparing and monitoring the investment environment and testing our thinking and the assumptions on which it is based are the best ways to position our investment program to generate strong returns, with acceptable risk, over the long term. . “
This has led the fund to consider a variety of plausible scenarios and consider how it can evolve and position the portfolio to be as robust as possible in those scenarios. While playing on its main characteristics and advantages of having a long-term investment horizon, a global portfolio approach and the ability to partner with high-caliber investment organizations on a global scale.
The paper highlights the paradigm shifts shaping the investment order in ways that encourage investors to rethink their portfolios.
De-globalization replaces globalization as the free movement of goods and services, investments and people across national borders slows down and in some cases is reversed. This has resulted in tensions between the world’s two largest economies as technological developments are more closely watched as part of national security policy.
Countries reaffirmed their national interests, control of national laws and emphasized the national beyond an open international system. National economic policies have evolved towards increased state intervention and control.
Technological innovations have enabled companies to develop operating models based on intangible assets, such as data and software platforms, leading to the rise of digital conglomerates. The benefits of innovation have led to disruption and dispersion within industries.
Many developed markets are grappling with an aging population and depend on migration to counter population contraction and aging. Asset inflation has exacerbated intergenerational wealth inequalities. In developed countries, young people can be disadvantaged in terms of job security, housing prices, higher education debt and record levels of national debt.
The physical climate risk has become more serious over time. Insured losses from natural disasters have increased from around $ 10 billion per year in the 1980s to $ 45 billion over the past decade (adjusted for inflation). Total direct losses have been four times greater than insured losses and have increased by about three times over the past 30 years. Firms with carbon-intensive operations and value chains are potentially vulnerable to revised market prices. Renewable energies are becoming more and more competitive compared to traditional production sources.
In the United States, corporate profits have grown from around 5 percent of GDP in 1990 to 8-10 percent today. This was motivated by the use of technology and innovation to improve the productivity of intangibles, favorable tax provisions on capital, restructuring, offshoring and automation, which reduced costs. If these trends come to an end or reverse (perhaps due to de-globalization and populism) and without new sources of growth, expect downward pressure on equity earnings and returns in the decades to come. to come.
The forces that brought inflation under control have either waned or are now reversed, and the response to the 2008 financial crisis and the more recent pandemic has increased the burden of public debt. Fiscal stimulus added to burgeoning rights that can only be met through pro-inflationary policy.
In the aftermath of the financial crisis, institutional independence was eroded by the introduction of measures such as quantitative easing, control of the yield curve and other forms of central bank intervention in financial markets. public funding with the aim of inducing or supporting budgetary expenditure. The pandemic has further accelerated this change.
As monetary policy reaches its limits and technological upheavals gain momentum with its low capital expenditure requirements, the traditional business cycle is threatened and traditional measures of fair value measurement are called into question. There is an argument that the base rate and the risk premium component of discount rates for risk assets should be structurally lower – and valuations structurally higher than they have been over the course of time. modern financial history.
Government bonds have been the defensive anchor of investment portfolios for over 30 years, with the traditional 60/40 equity bond portfolio being based on a negative correlation between the two asset classes. Nominal bond yields are considerably lower, reducing the possibilities for redemption of bonds. Investors ended up paying to profit from bond rallies rather than getting paid. If inflation starts to rise, the bond-equity correlation could prove to be much less beneficial in the future.