What are the major global events currently impacting EM Pension markets?
Still very low absolute interest rates and yields across global developed markets is driving considerable interest in emerging market assets. Such interest however is extremely fickle and hot money flowing into emerging market bonds and equities rapidly dissipate at the first sign of increasing interest rates globally or flaring geopolitical tensions resulting in risk-off sentiment and a flight to safety. While the direction of interest rates is somewhat more certain, political tension and investor sentiment remains impossible to accurately model and as such the volatility of emerging market asset prices has become not only heightened but driven by unquantifiable and unpredictable factors in the short to medium term. Yields and valuations do however appear attractive both in absolute and relative terms.
Where do you see the major risks for Pension Funds in the next 5 years?
Yields across the developed world remain well below their pre-financial crisis levels even though they have increased marginally off their lows. Such low levels of interest rates have encouraged an inordinate amount of new issuance of debt from corporates across the world who could raise debt cheaply. This cheap money has found its way into global financial markets and had perverse impacts on asset prices through record levels of share buybacks (in excess of $700 billion in share buy-backs in the US in 2018) as well as corporate investment in projects where returns are only just marginally above a very low cost of capital. These are clearly not long term sustainable drivers of share price growth. While corporate leverage is not only the highest in absolute terms that it’s ever been but also the highest it’s been relative to GDP (even higher than just before the financial crisis), it appears that a storm is brewing while the world economy is forced to deleverage as interest rates rise.
Increasing political disjointedness across the globe also poses a big medium term threat. While policy response to the global financial crisis could be swift due to political and economic collaboration, the likelihood of that happening at the next global economic slowdown has been reduced. This is due to both political differences but also as a result of reduced tools in the arsenal of global policy makers as interest rates are half or even lower than half of where they are prior to the global financial crisis and sovereign debt balances are significantly higher.
Where do you see the major opportunities for Pension investing in the next 5 years?
For the patient investor, opportunities remain abound both in the listed and unlisted space. In the listed space, valuations discrepancies within global financial markets are high with growth and prospects for a number of sectors and countries which have not been caught up in investor hype remaining an attractive source of returns.
A number of companies have allocated capital in a disciplined way even through a prolonged wave of cheap corporate credit and share prices of such companies have not always been adequately rewarded to reflect such a reality. While such shares generally find themselves classified as Value biased sectors and shares in the current environment (including global Financials, Industrials and select Resource and Consumer Discretionary shares), investors need to remain wary of not been caught in a value trap. The risk of being caught in a Value trap has increased notably as a number of industries have been structurally disrupted by technological factors.
Unlisted investments offer a compelling investment case for a number of reasons, not least of which is the long term return potential available without the heightened short term volatility of the listed markets. Unlisted investments offer pension fund investors a diversified source of return, the prospects of higher real returns over the long term and also the ability to make a positive social impact for all stakeholders within society. While there are some unlisted investments where the thesis could play out over a 5 year time horizon (for example certain classes of unlisted debt) these alternate investments are generally more long term in nature.
Where do you see a major sell-off or buy-up trend occurring in Pension Funds over the next few years?
As retirement funds continue to face mounting challenges of funding their liability requirements they is likely to be increased appetite for unlisted, alternate investments offering higher long term returns in exchange for reduced liquidity.
While this phenomenon is likely to be a more gradual long term structural shift, shorter term trends are likely to be sustained or even increased appetite for emerging market assets as yields and valuations coming into 2019 appear attractive. Political instability across the world impacting investor sentiment does remain the largest caveat to such a scenario playing out.
Another attractive medium term investment opportunity are companies which have managed to grow earnings at a steady rate above their cost of capital without utilising excessive leverage and consequently impairing their balance sheet. While the companies which have disrupted industries and grown at a prolific rate such as US Technology shares have already to a large extent been rewarded and re-rated to price in such a dynamic, there remains a number of companies within the previously mentioned sectors which offer an opportunity for stable, compounding growth with reduced risk of multiple de-rating given undemanding multiples.
The largest risks to pension fund investors within either fixed income or equity security markets remains the ubiquity of excessive leverage.
Where in your opinion are PF investors currently getting it wrong?
A continued fixation with short term returns as a result of severely under-funded pension funds is a significant driver of perverse behaviour which is likely to have very poor long term outcomes not only for investors from a return perspective but also for society at large. The quest for short term performance from pension fund investors drives sub-optimal capital allocation decisions from company management in order to appease the investment community and drive short term price appreciation. Capitulation to such short term pressures results in activities such as borrowing of cheap money to buy back shares, or invest in low return projects just to generate a return on assets and boost short term profitability at the expense of long term sustainability. Other measures taken to appease short term earnings demands includes a cutting of jobs, reducing wages or not increasing wages at a commensurate rate or cutting expenses in other ways which have similar detrimental outcomes for society at large. Such harmful effects on long term returns and the stability of the global community does not even take into account the deleterious company management compensation structures based on short term incentives. With inequality across the globe at dire levels, an increasingly large proportion of the public are becoming disillusioned with capitalism and the free market economy. While it may be simplistic to assume just shifting focus across the value chain to more long term outcomes would solve such issues, a greater appreciation for long term positive outcomes for all stakeholders would undoubtedly have a positive outcome for all. As asset owners, pension funds, and as a conduit their stewards of capital, hold the greatest ability to change such a short termism mind set for positive outcomes.
What would you Say is the role of the conference for you on the above? How this conference will help
you achieving this objectives? What outcomes would you expect from the conference?
Forums such as these are ultimately about information sharing and understanding how to access sources of return for pension fund investors without jeopardising long term return sustainability. Achieving such outcomes generally happens in two stages. The first stage is to be made acutely aware of all the major risks and just how pressing each is and the second stage is to be provided with greater insight into investment strategies or a change in outlook which seek to address these challenges identified.