CIO Morning Bell: Widening The Investment Universe

CIO Morning Bell

Are traditional safe-havens such as gold as attractive as they used to be, or is ‘digital gold’ the new inflation hedge? What does an ESG positive investment portfolio mean in terms of returns, and how does China’s technology ambitions and decoupling from the West factor into emerging market asset allocation strategies?

These were topics debated by leading global private bank chief investment officers at the annual Global Private Banking Innovation Summit, CIO Morning Bell, which was moderated by Pravin Raveendran, founder and CEO of AssetOwner.CO and hosted by Global Private Banker. (Editor’s Note: You can watch the full video here.)

With countries committing to net zero carbon emissions by 2050, some of the world’s largest asset management firms have announced they will divest from companies that do not have a carbon reduction strategy. The private wealth management community are still working out what net zero and sustainability means for them. One burning question, says Raveendran, is whether an ESG positive investment portfolio could materially impact returns? “We don’t think there is a trade off,” says Prashant Bhayani, Chief Investment Officer, Asia at BNP Paribas Wealth Management. “It’s about ESG integration, another factor in our investment framework, which leads to quality bias in your portfolio and lower volatility.”

UBS Global Wealth Management’s Chief Investment Office (CIO) has applied an ESG filter to its portfolio since 2018. “Our experience so far every year is that ESG and sustainable investment strategies have slightly outperformed global strategies,” says Adrian Zuercher, Head of Global Asset Allocation at UBS Global Wealth’s CIO. “There is less downside risk and volatility. Last year, green bonds barely had any drawdowns as they are largely held by institutional investors who hold them till maturity. A lot of people focus on E, but S and G also come into play, in reducing downside risk.”

“ESG mandates are not only doing slightly better, but significantly better,” says Tuan Huynh, Chief Investment Officer for Europe & Asia at Deutsche International Private Bank. Huynh describes ESG as an investment philosophy, not an asset class. “We hope in three-to-four years we’re not talking about ESG because it has become an investment standard.” Currently, Deutsche Bank gives clients an opt-out strategy in terms of whether they want to apply an ESG filter to their portfolio. But Huynh says clearly the trend in the next one or two years is towards ESG and sustainable investment. Companies may be forced to adopt this strategy more quickly, he adds, in light of tougher EU regulations on sustainable investing. The EU’s Sustainable Finance Disclosure Regulation aims to integrate ESG strategies seamlessly into investing and to minimise the practise of “greenwashing,” or companies making exaggerated claims about their environmental credentials.

Regulators want to create standards that more clearly define what ESG-compliant investments look like. But Zuercher doesn’t believe it will limit ESG investment opportunities. “We can widen the investment universe and get more liquidity into this asset class,” he says. With the investment universe for green bonds or specific-focused ESG funds increasing, Alex Wolf, Head of Investment Strategy for Asia at J.P. Morgan Private Bank, says settling on a clearer set of standards and measurements will clarify the investment universe for clients. “Over time it should be easier to filter companies based on ESG criteria because a lot more information will be available,” says Bhayani of BNP Paribas Wealth Management. 

Digital gold vs. physical gold

As ESG becomes just another factor in wealth manager’s investment framework, is “digital gold” also likely to capture their attention? In 2020, bitcoin was one of the best performing assets, outperforming traditional investor safe havens such as gold. But is digital gold or cryptocurrency an obvious replacement for physical gold? “There are thousands of cryptocurrencies, and even the most popular one, bitcoin, is extremely volatile,” says James Cheo, Chief Investment Officer for Southeast Asia at HSBC Private Banking and Wealth Management. “It doesn’t exhibit the characteristics of gold, which has been around for thousands of years.” In financial markets, when risk assets go down, gold holds its value. But Cheo says bitcoin does not exhibit these credentials yet. “It’s too early to have that substitution effect. Cryptocurrency is an emerging innovation rather than a safe-haven portfolio diversifier at this stage.”

Zuercher of UBS is neither a fan of gold or volatile digital cryptocurrencies that behave more like speculative assets. “On the crypto side there is a lot of interest for our clients,” he says, “but we don’t have it in our portfolios at this point. It’s not a substitute for gold, but maybe a diversifier from gold.” Gold has a very low expected return over the next 10-to-15 years and equity type volatility, says Zeurcher. “We don’t buy the safe haven argument. During some periods of stress gold can do well, but it’s a poor inflation hedge.” UBS predicts the price of gold will reach much lower levels  over the next 12 months as real interest rates rise and tapering off by the US Federal Reserve commences.

Digital gold may be out, at least for now, but private wealth managers are looking anew at emerging markets asset allocations in light of China’s decoupling from the West as relations with the US continue to sour. Huynh of Deutsche Bank says the trade war between the US and China, which reached its peak under the former Trump administration, has spilled over into political and technology questions. China has a five-year plan to accelerate its technology leadership in areas such as artificial intelligence, quantum computing, semiconductors and space. “The next 10 years will see a battle between the two giants [the US and China],” says Huynh, “with Europe falling behind.” This battle is likely to express itself in higher asset allocations of Chinese equity markets in global equity portfolios.

Bullish on China

Is this indicative of a wider investment trend away from developed to emerging markets because of China’s growing power, asked AssetOwner.CO’s Raveendran? “This has already taken place,” says Huynh. “If you look at asset allocation 10 years ago, the share of emerging markets in a global investment portfolio has more than doubled from a relatively low level. In the next 10 years that could be another level of increase of emerging markets, specifically Asia and China. European investors are asking for higher emerging markets in their portfolios.”

From an asset allocation perspective, wealth managers are less inclined to lump emerging markets all in together. Bhayani says it looks at North Asia (Taiwan, China and South Korea) differently from other emerging markets. “More fund managers are meeting Chinese companies and better governance standards will result in better returns on capital as China transitions to a middle-income and innovation economy,” he explains, adding that India has been overlooked globally in the medium term as China’s population is ageing and GDP trend growth is expected to slow.

J.P. Morgan is even more bullish on China, with its head of investment strategy for Asia, Wolf, saying that it sees China as worthy of a standalone allocation separate from other emerging markets. “Most long-term capital assumptions for emerging markets over the last 10 to 15 years have been way off,” he explains, “particularly emerging markets ex-China. Emerging markets are more of a tactical position. They do well when the dollar’s weak and trade is strong, but it’s hard to make a structural case for emerging markets ex-China.”

Huynh says Deutsche International Private Bank is moving in the direction of stripping China out from other emerging markets. “Maybe in the next five to seven years, China could become a single region in terms of fixed income and equities,” he says.

Zuercher at UBS says China is driving the whole emerging markets story. “We see a shift from European investors that are happy to have 50% asset allocation in Asia.” UBS has 100% on shore multi-asset class Chinese strategies and portfolios for onshore clients. “We’re now seeing interest from offshore investors to tap into these strategies. The more interesting part in a low interest-rate environment is onshore government bonds. We’ve replaced US high-grade bonds with onshore bonds for those that want to have onshore exposure in China.”

With inflation ticking upwards, investors are wondering is this a permanent or transitory phenomenon? Some market commentary suggests the Fed is underestimating the risk of inflation, says Raveendran. Could we be left with the worst of the stagflation markets experienced back in the 1970s or the 2007-2010 period? “To have hyper inflation in the system is rare,” says Cheo of HSBC Private Banking and Wealth Management. “You need a perfect storm and wage pressures. In the 1970s, the spark was oil prices. Today, has a lot to do with temporary factors, pent-up demand and supply bottlenecks as economies reopen. That is why we’re seeing inflation picking up, but it will start to stabilise going into 2022. Don’t be afraid of inflation, but be prepared for it,” says Cheo.

From an asset allocation point of view that means putting tax exposures into reflation trades, looking at sectors that will do well when bond yields go back up again, and looking into inflation hedges like gold or commodities. Wolf says J.P. Morgan favours broad reopening and reflation and cyclical ideas. “We’re above consensus on US and global growth. We favour equities relative to debt. Within equities, we’re looking at industrials, materials and energy broadly.”

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