Taking ‘Smart Risk’ to Achieve Active Return 

Andreas Utermann 

 

2/6/2014 

Global CIO Andreas Utermann highlights key themes from our recent Investment Forum in Hong Kong, including the role of “disruptive technologies” in active management and the importance of risk assets in today’s low-growth, low-yield, low-inflation world.
Since its inception in San Francisco in 2011, our Investment Forum has been a source of inspiration and a testing ground for our medium- to long-term investment outlook and thematic hypotheses. At our most recent gathering in Hong Kong in January, we reflected on the bold decisions taken since our last forum there — that we are living in an era of financial repression, and that for investors, the biggest risk may be to not take any risk — and discussed the future investment horizon.

Understand

The relative stability of our macroeconomic outlook — which calls for an environment of low growth and still-low inflation — gave us the opportunity to explore more specific trends that have been shaping capital markets and to consider how investments should be made in the future.

For us as an active asset manager, one of the most important, if somewhat insidious, trends in the industry is that it is becoming more and more difficult to deliver an active return for clients, in particular in equity investments. We will provide more insights into this trend in future publications, but with the knowledge that distinguishing between future winners and losers is at the heart of active management when it comes to stock picking, we devoted an Investment Forum session to the “disruptive technologies” that could shape our future. The development and applications of advanced robotics, advanced materials and next-generation genomics are among the new technologies we are paying closer attention to as we scrutinize corporates’ business models, sector developments and economic growth drivers.

In our discussion about ongoing macroeconomic trends, we started to review the inflation outlook, understanding that inflation — or, more precisely, its opposite: deflation — can have a significant impact on all asset classes. Inflation has, if anything, surprised to the downside in recent months, and it is the threat of deflation rather than inflation that commands the attention of the latest generation of central bankers. Nevertheless, we believe that inflation will stabilize and not turn into the type of deflation that has plagued Japan until recently. Taken together with our scenario of moderate but sustainable growth, which gained further support during the last few quarters, price levels in developed markets should stabilize before edging up in the next two to three years. Both significant inflation and deflation are unlikely in the coming quarters.

Act

As at every Investment Forum, we discussed the investment implications and how best to act on our insights.

To start with our own investment processes, the evolution in active management needs to continue: With the support of our GrassrootsSM Research teams and our buy-side company research, we need to continue to pick stocks and capture the big trends — including in, but not limited to, technology, which will reach far beyond the technology sector. The quality of our analysis and the conviction this gives us in our investments is what sets us apart.

Opportunities for outperformance need to be captured by judiciously increasing the active share in a portfolio, expanding the investment universe (e.g., by including small and mid caps instead of sticking to large-cap investments) and increasing operational excellence through alpha extensions. Our conviction is, the more active managers are, the more successful they should be.

Taking our macroeconomic scenario into account, the chase for active return needs to be combined with the willingness to take smart risk. As we have previously stated, we believe there is no alternative to taking risk:

Income solutions with low duration risk might be the first choice for investors.
A next step might be corporate bonds, including high yields. There is still a huge demand for credit risk, and economic development and earnings growth should continue to support the improvement of corporate balance sheets.
Notwithstanding their strong run so far, equities, notably dividend strategies, should continue to be a focus. Developed-market equities have already enjoyed re-ratings, leading to an expansion in multiples; further share-price growth will likely need to be underpinned by earnings growth, and will therefore be more selective.
Institutional investors would be well advised to go into more illiquid assets, which, in addition to generating steady cash flows, should command illiquidity premia in return for longer holding periods.

In a low-yield, low-inflation environment, there should be opportunities for active return for those who are willing to take smart risk.




A Word About Risk: Investing involves risk and you can lose money. Equities have tended to be volatile and, unlike bonds, do not offer a fixed rate of return. Dividend-paying stocks are not guaranteed to continue to pay dividends. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets. US government bonds and Treasury bills are guaranteed by the US government and, if held to maturity, offer a fixed rate of return and fixed principal value. Bond prices will normally decline as interest rates rise.
 
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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