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2019 Investment Views

Investing for a better tomorrow

28 November 2018
Authors: John GreenCo-Chief Executive Officer, Mimi FerriniCo-Chief Executive Officer

John Green and Mimi Ferrini look at sustainable investing and what 2019 holds in store.

Transcription

John: I think clients are spending a lot of time thinking about this question of really committed sustainability investing. I think we have seen a lot of what we call the exclusion process for sustainability.

I know that, from an investment point of view, we spend a lot of time on integration but we have also spent a lot of time on the question of how do you do sustainability with an inclusion mind-set? I think if asset owners spent time thinking about the sustainability question over next year, these areas are going to become more and more important in portfolios.

Mimi: Absolutely. I think it is becoming mainstream how corporates are excluded and included in mainstream portfolios on an ESG basis. I think that is a good trend. We like things to be a lot more transparent on all those factors. I also think that investors would probably want some specialist exposure in companies and perhaps in sectors and industries like the energy transition, environmental transition type of strategies. So the demand for mainstream solutions definitely requires investors to have given it thought and to have integrated that disciplinary process.

John: And the process of helping asset owners really think about how they can position their portfolios to benefit from the process of decarbonisation is something that we are spending a lot more time on, building portfolios that specifically pick stocks that are going to benefit significantly through this decarbonisation process and asset owners allocating specifically to those kinds of portfolios really operates as a kind of insurance against the process of climate change, the process of decarbonisation too.

Mimi: Yes and I would say that our industry, can make a big difference in the decarbonisation of the world. We can mobilise our clients’ assets into helping corporates being held accountable and to decarbonise.

So our industry is a very valuable tool to help decarbonise the world. What we need from investors is to mandate their asset managers to take long-term enough views to get them to hold the companies they invest in accountable.

John: Yeah and there is no doubt that that conversation is really escalating within asset owner structures and asking the question about how do we positively, really positively, help and then benefit.

Outlook for China

Mimi: So, John, just in your view, where do you think investors will be looking to for differentiated returns going forward?

John: I think a very good question but there are a few spaces that we are seeing a lot of investors and asset owners paying close attention to as opportunities for their portfolios. I think the first one (and this has received a lot of maybe headline engagement), as asset owners look deeply, they are really thinking about how an allocation to China, either in equities or in bonds, can make a real difference to their portfolios.

You know, if you quote the high level numbers, China today is the second or third biggest equity market in the world. It is the second biggest economy by GDP and, if you are a harvester of the equity risk premium, you need to be thinking about how to take advantage of that opportunity. I think that the recent pullbacks in market levels provide a significant moment for asset owners to think through that and to make decisions around how they decide to allocate to that opportunity in their portfolios.

We see lots of asset owners committing to very discrete allocations because this is not a space that is picked up typically in global indices and therefore gets left out and we are seeing some asset owners being comfortable with the global index coverage. That, in itself, is going to change significantly over the next 2-3 years. So I think asset owners that move ahead of those changes are also going to benefit from the flow effect.

So I definitely see China as a major potential needle-mover in client portfolios over the next 2-3 years and those that grapple with it in the next year can really get ahead of the flow.

Mimi: I would add to that, John, I would tell you that, running a team that picks stocks in the China equity universe, one can definitely see an improving trend of governance within corporate China. . .

At this point in time, it is easier for investors to access China securities with the market opening up. It is in a market that has recognised that it needs foreign investment to sustain the growth in that economy. So we are finding it easy to invest and to settle in those Chinese securities

John: And I mean the fact that a really big proportion of ownership in that equity market is retail, it is not going to change overnight and that the retail behaviour is what is driving share prices, is really a significant opportunity for active management too I would expect.

Mimi: Absolutely. I think with a lot of noise in the market, if you have a very disciplined process that breaks the corporate down to its fundamentals and you are disciplined about when you are investing you could capture the opportunity. So it is a stock-picker’s dream.

John: And everything we are hearing from President Xi is just that this opening up trend and journey is unstoppable. Having spent a lot of time in China, I absolutely support that view. So investors who are thinking about it need to act quickly I would expect.

Mimi: I would totally agree with you. I mean there’s a lot of scepticism around China and its approach to environment, its social and its governance issues. They live with it every day. You know, from an environment perspective, it is very visible the challenges that they have. From a governance perspective, they have to improve their governance and there is an improving trend, still not perfect but they need to do that

John: And everything that we see is that that trend is firmly entrenched.

Challenges in 2019 for investment portfolio

John: So, Mimi, we have had a very interesting start to the final quarter of the year. As we go into 2019, that presents some interesting challenges I would expect for investment portfolios. How are you seeing it? How are you feeling about it?

Mimi: Well, John, I think we are heading into an environment where what we had as tailwinds are going to be turning to headwinds. We have had the benefit of quantitative easing, cheap money. These have all helped markets and the valuation within markets.

John: And I suppose the geopolitical environment right now doesn’t help either – trade wars happening out there.

Mimi: This is all going to affect profitability of corporates and this era that we are going into is going to be very important for active managers and I think for our investors to pick managers that can understand investment cycles, can make sure that they have deep fundamental research, they have long holding periods, they engage companies.

John: So maybe we are moving from a period of really capital driving returns or rerating driving returns.

Mimi: Cash flow is going to be key. We are going to be looking for sustainability of earnings and companies that have a good capital discipline, that have a good dividend policy. We will be looking for those characteristics in our portfolios.

John: And on the bonds side, I mean a very interesting dynamic at the moment in terms of the views on interest rates, where those might go and how those might affect bond returns. It seems that people are really at both ends of that spectrum, some saying not much change, some saying big change. How are you feeling about that?

Mimi: Well, I think there is going to be very little place to hide going forward. I think that we have seen at the beginning of this quarter a huge amount of volatility in the fixed income markets. A lot of it has been driven by the dollar strength. There has also been a potential contagion effect within emerging market fixed income that has made investors very nervous in the fixed income market but I do believe there are some very good sovereign issuances out there that are under-priced at this point in time. I think the fixed income landscape has been tarred all with the same brush and hence the close correlation it has had with the other markets and so on. So I think selectively there are opportunities out there for fixed income investors.

Emerging markets

John: Emerging markets have suffered quite a lot in the sort of recent volatility. We have seen, interestingly, from the clients’ side, more commitment to emerging markets, potentially buying in at lower levels, buying the long term story of emerging market growth. How do you feel about it over the next year from an investment perspective?

Mimi: I think we must get an alignment of time horizons with clients here and I think, when it comes to investing in emerging markets, one needs to understand the cyclicality of it and sometimes there’s a mismatch. Clients are expecting short-term returns and, when there is a disappointment in that, managers are questioned at the wrong time almost.

So I see that emerging markets are going to continue growing in relevance in our clients’ portfolios. They are going to continue becoming an alpha-rich environment for our clients to invest in and I think that we have some really good opportunities at this point in time to include in our clients’ portfolios, given the pricing that we are currently facing at this point in time.

John: So looking down into 2019 and beyond, slightly lower returns but you feel a really good environment for alpha, investment teams are excited about the opportunities that they are seeing to take risk and that that should therefore deliver better outcomes for the clients who take an active position.

Mimi: An active position with a long-term view horizon, I would totally agree with you that this is the time to be looking closer at mispriced opportunities that have fallen victim from the fear frenzy in the stock markets.

John Green
John Green Co-Chief Executive Officer
Mimi Ferrini
Mimi Ferrini Co-Chief Executive Officer

Important information

This content is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual outcomes may differ materially from those stated herein. In Australia, this document is provided for general information only to wholesale clients (as defined in the Corporations Act 2001). In South Africa, Investec Asset Management (Pty) Ltd. is an authorised financial services provider.

All rights reserved. Issued by Investec Asset Management, issued November 2018.

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