If long-term investors want to continue to be successful going forward “the first thing they have to do is leave the past behind,” said Raphael Arndt, chief executive of Future Fund at the Milken Institute 2022 Global Conference on May 4.
“The whole world is changing, and these changes are in demographics, in politics, geopolitics and in policymaking — and they are flowing through to how economies work, how financial markets work,” said Arndt.
According to the chief executive of Australia’s $171.4 billion (A$248.9 billion) sovereign wealth fund, a whole series of cycles are currently converging on the global investment landscape.
In tandem with the threat of further rising rates and inflation, one of the main reasons for the changing economic conditions is the shift in generational thinking. Millennials are now assuming their places as the marginal voters in democracies, organisational leaders and decision makers.
“They’ve had a very different life experience to Gen X, or boomers, in terms of how they've experienced the world, getting an education, finding a job, their feelings about investing in assets or not and Gen Z and zoomers are coming along straight behind them. Their view of politics, their view of who to vote for is affecting institutions and policy makers are reacting,” said Arndt.
“If you've worked in the industry for any length of time that is an impediment not an assistance to you,” he said. “Modern portfolio theory, mean variance optimisation, capital asset pricing model — these are all extremely unhelpful because it's all based on data collected since World War 2, and the world's worked a certain way in that period but it doesn't work that way anymore.”
DEGLOBALISATION OF FINANCE
Speaking on the same panel, Rohit Sipahimalani, chief investment officer of Temasek said that there are still many investment trends that he believes will remain valid over the next decade, but investors need to adjust the lens with which they assess these opportunities.
“Biotechnology, healthcare, sustainable living, new energy, clean transportation, food, water, waste, materials, and the changing nature of consumption, particularly in emerging markets,” are all trends that Singapore’s $273 billion state investment fund has been investing in over the last few years and will continue to pursue in the years to come, he said.
However, institutions like Temasek must now prepare for a deglobalisation of financial markets when investing in these trends, a situation which has been accelerated by geopolitical tensions and the Covid-19 pandemic, said Sipahimalani.
“Effectively, we see the world as being bifurcated, you have a China bloc and a Western bloc, and it is becoming more important to invest in companies who have large domestic markets and are somewhat self-contained,” he said.
“For example, in China we invest in biotech companies which address or do drug development for the China market. Many of them have partnered with US multinationals to get FDA approval for their drugs with the idea that they will also sell in the US. Now we're just assuming that the second doesn't happen. If it does, it's a bonus,“ said Sipahimalani.
“You need to underwrite your investment based on the domestic market opportunity, that's the key issue for us. We're looking at everything from a geopolitical lens and having large domestic markets is important.”
For many investors, recent asset allocation decisions have been heavily influenced by volatile geopolitical developments and levels of inflation that were widely initially predicted would be transitory.
With inflation now in the high single digits and rising, the transitory narrative has been abandoned, and Temasek’s CIO sees inflation being more of a “chronic” ordeal to contend with over the next decade.
“Over the last 20 years when we constructed our portfolio, we always talked about having things that did well in all different environments and finding a balance, but the high inflation environment was not something that people looked at that seriously,” said Sipahimalani.
Temasek is now taking inflation much more seriously, and there has been debate amongst Sipahimalani’s team whether or not the fund should be investing in metals and mining.
“More importantly in almost every investment we do now, we think looking at the pricing power of that company or business becomes is much more important,” he said.
Managers of pension funds and endowments are required to make strategic decisions to ensure that their return obligations can be met decades ahead. The economic upheaval of inflation, geopolitics and Covid has created an environment where short-term investing can be rewarded generously, but long-term investors must keep their capital patient, according to Sipahimalani.
“You have to think about portfolio construction from at least a five to 10-year perspective, and have that really shape and drive the portfolio,” he said.
Due to the nature of Temasek’s portfolio mandate - which has a 75% allocation to either private equity or in public companies where it owns a controlling or very large stake - it does not have the liquidity to be a nimble short-term investor.
“Within our strategy, we can be nimble in a sense, and do deals here and there. But the deals we do in any one year will form only a single digit percentage of the portfolio. It takes at least five years to make a meaningful shift to our portfolio so it’s important for us to have a somewhat all-weather portfolio, which will not be unduly biased towards one environment.
“I wouldn't say that things are the same, clearly, things have got to be quite different. But also, I do think some of the long-term trends that were there, before Russia invaded the Ukraine and before Covid, are still going to be valid for the next decade.”