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As long term trends such as the rise of China, sustainability and digitalization shape the investment landscape, investors must adapt their portfolios to benefit from the new market paradigm.
Highlights
At 蜜豆视频鈥檚 Sovereign Investment Circle 2023, we met with a range of external academics, SWF officials and internal speakers who shared their views on the key themes at the forefront of sovereign investors' minds. Max Castelli, Head of GSM Strategy & Advice addresses the five key takeaways:
We are in a 鈥渘ew paradigm鈥 that according to some event participants has the potential to 鈥渞eshape the world鈥. Investors will have to adapt to fulfil their mandate, which is to generate adequate returns to benefit their country. This new paradigm is still evolving and lots of uncertainty remains as to what the 鈥渘ext regime鈥 will look like.
In his opening remarks, Professor Arturo Bris from IMD, 蜜豆视频鈥 academic partner for this event, talked about the shift from the 鈥渆ra of uncertainty鈥 to 鈥渢he era of ignorance鈥. Many of the shocks that hit the global economy 鈥 e.g., Covid and the war in Ukraine 鈥 were largely unforeseen. In such an environment, it is difficult for corporate leaders and investors to make long-term plans. Investors need to have processes and capabilities to respond quickly to events; in other words, they need to develop a culture of urgency. In investment terms, this means being more tactical then strategic.
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The restructuring of global supply chains will affect investments over the next 10 years. In the post-pandemic era, we anticipate that countries will focus on three approaches: reshoring, regionalization, and replication. These strategies will impact countries and corporates in different ways and there will be both winners and losers. This requires a mind shift for strategic investors like SWFs.
The best example of this mind shift was outlined by a participant from a leading Asian SWF in his remarks at the conference. His institution has traditionally focused on megatrends as key drivers of investment decisions, and have recently added geopolitics as an additional layer to their strategy. For instance, as it relates to deglobalization and fragmentation, their strategic investments are now focused on corporates that have access to large domestic markets (export potential is now considered a plus), and the resilience of their international value chains as a secondary factor.
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President Xi wants to reclaim China鈥檚 status as the world鈥檚 major economy, reprising its status from the 14th to the 19th century. The 鈥楥hina Dream鈥 is focused on a new development philosophy (Dual Circulation, Common Prosperity) and Community of Shared Future for Mankind, i.e., the Global Development Initiative and the Global Security Initiative.
One of our panelists noted that China seeks to challenge the US status as an international hegemony but wants to live by the rules internationally. As to whether China catches up to the US economically, much depends on structural reforms, unfavorable demographics, and innovation that has so far lagged behind the US. While China will not wither away, it will not become the biggest economy in the world, according to the panelists, with the country reflecting already-high debt levels.
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With regards to sustainability, many of the representatives of SWFs discussed how this trend is steadily transforming their organizations due to the integration of ESG in their operations. Most agree that this is a long-term journey and that several milestones need to be met before it can become a fundamental pillar of their investment strategy. Returns remain of paramount importance but sustainability offers some high alpha opportunities, particularly in the alternative asset space.
With regards to the politicization of sustainability in the US, SWFs appear to be focused on implementation. SWFs often engage with their US counterparts and so far, have not detected a slowdown in co-investment opportunities in this area.
Return assumptions of 7-8% have been effectively unchanged for 50 years. But the operative environment has changed. Returns are likely to be lower in the future and more risk will have to be taken to achieve them. This has implications for the management of shareholder expectations and return target definition. Many long-term investors express their objectives in terms of 鈥淐PI plus鈥 but in the current inflationary environment these targets are difficult to achieve. While these investors are not ready to revise down targets, a debate has begun, and the future path of inflation will determine the direction going forward. What is certain is that capital will have to 鈥渟weat鈥 much harder in the future to generate returns comparable to those in the past and there will be an increased emphasis on TAA.
In an increasingly complex and fragmented world, liquidity is at a premium. Will this be the end of the endowment model adopted by many SWFs over the last two decades? Not necessarily, as alternatives are still considered an important asset class for SWFs given their lack of liabilities and high-risk tolerance. However, there will be an adjustment in the share of illiquid asset classes in SAAs in the future.
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