The double digit drawdown in global equities in October provided investors with compelling evidence, if it were needed, that the challenges they face globally as 2019 approaches have increased in both number and significance. The aging cycle, reduced support from monetary policy, higher equity market volatility, trade wars, Brexit, European political risk and rising bond yields, to varying degrees all threaten risk assets. Throw in the perception of heightened emerging market (EM) vulnerability to desynchronized and moderating global growth drivers, higher US funding rates and a stronger US dollar – and the quandary facing asset allocators looks stark.
So how should investors approach the coming year given those challenges? In the Mid-Year edition of Panorama, we argued that investors would have to think differently, be more precise in their risk-budgeting and work harder for risk-adjusted returns than they have done for the majority of the post-financial crisis period. Six months later, that view remains unchanged.
As ever, genuinely diversified risk premia should, in our view, remain the bedrock of investors’ portfolios. And as Ryan Primmer, Head of Investment Solutions, points out in our macroeconomic outlook, above-trend global demand growth, robust corporate earnings and more attractive valuations are still likely to support positive returns for global equities in 2019. In our view, this is not yet the end of the equity bull market. But on a risk-adjusted basis global equity returns are likely to be constrained by a continuation of the higher volatility regime and investors’ understandable reluctance to pay peak multiples for what might prove to be peak earnings.
Within the traditional asset classes we would highlight once again that higher individual security dispersion within equity and bond universes is likely to go hand in hand with higher volatility. This therefore remains an environment in which active managers should prosper on a relative basis. Flexibility and staying nimble are likely to be important qualities as opportunities and dislocations ebb and flow both across and within asset classes. We therefore continue to advocate a bias to high conviction, active investment styles. After a difficult year in 2018, the outlook for Chinese equities specifically and for emerging market asset classes more broadly is likely to remain a key focus for investors well into 2019 and beyond. The main takeaway from the views of our EM equity and fixed income teams is that the longer-term fundamental story for EM remains intact. We accept that there are headwinds that are likely to mean continued volatility across EM asset classes in the short-term – but for patient investors current entry points look attractive in a long-term context. Bin Shi, Head of China Equities, argues that investors have not yet fully appreciated the changes made by the Chinese authorities to support the economy and equity market, nor recognized that in recent weeks China has opened up key industrial sectors to investment from overseas companies – an issue that had previously been a source of major disagreement with the US.
In our view, the case for alternative assets also remains compelling in the current market environment. In the following pages we outline the outlook across real estate, private equity and infrastructure markets. With greater flexibility and the ability to reduce and neutralize market beta, the rationale for selective hedge fund exposure is a logical extension of the case for high conviction, active long-only mandates. Bruce Amlicke, CIO of UBS Hedge Fund Solutions, outlines what he sees as a potentially very positive environment for a number of hedge fund strategies. After a year characterized by mega-deals, we see an evolving opportunity set within the merger arbitrage space. Our merger arbitrage team highlights the low beta opportunity for skilled managers created by continued geopolitical and regulatory uncertainty.
Amidst the breadth of medium-term investment insight across traditional and alternative asset classes, this ‘Investing in 2019’ issue of Panorama focuses on an increasingly important structural investment theme: sustainability. As a global leader in this space, sustainability factors are an integrated part of our investment processes across asset classes and across both active and passive approaches. We take the opportunity to highlight the potential for innovation in rules-based, carbon-aware equity strategies, and, separately, the vital role that stewardship and active corporate engagement can play in achieving sustainable investing targets. As our sustainable and impact investing team makes plain, long-term drivers of corporate performance overlap considerably with sustainability issues in general and stewardship in particular. The relationship between active corporate engagement and long-term financial metrics is, in our view, hardly coincidental. It is also a timely reminder of the benefits of focusing on long-term drivers of return, even when the short- and medium-term challenges to risk assets are dominating headlines.
We look forward to our continued partnership with clients in the year ahead.