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Big on trends
THE BUSINESS TIMES' WEALTH ROUNDTABLE
Genevieve Cua, BT Wealth Editor sounds out wealth experts for their views on mega investment themes.
John Woods is Chief Investment Officer Asia Pacific, Credit Suisse. He is responsible for developing regional discretionary and advisory investment strategies across and within asset classes for private and institutional clients in the Asia- Pacific. He has 25 years of investment management experience in fixed income and currency markets. He enjoys a good game of tennis in his free time.
Cesar Perez Ruiz is Chief Investment Officer, Pictet Wealth Management. Cesar has more than 20 years' experience running investment strategies for both wealth and asset management, with a strong bottom-up equity portfolio management track record. When he is not looking at markets or reading business publications, he likes watching Real Madrid and looking after his kids.
Johan Jooste is Chief Investment Officer, Bank of Singapore. Johan has 20 years of experience covering financial markets in foreign exchange, fixed income and multi-asset investing, and hedge funds. Most recently he was chief investment officer of Azure Wealth, a private client wealth management firm. In his spare time Johan devotes attention to collecting antiquarian books and enjoys fly-fishing in remote locations.
INTEREST rates, inflation and macroeconomic or geopolitical conditions may cause markets to spike up or down. Investment mega trends, however, may serve to anchor your portfolio for the medium and long term. We ask experts to share their picks of the big investment themes of the future.
John Woods: As investors wonder how best to handle high valuations of many assets, they automatically turn to thematic investments that can benefit from long-term societal trends. These investments do not depend as much on the daily ups and downs of the financial markets, but seek to profit from the predictability and sustainability of multi-year trends. Demographics, transformational socioeconomic and political developments as well as technological and scientific progress are at their core.
Credit Suisse recently launched Supertrends: Angry Societies - Multipolar World; Infrastructure - Closing the Gap; Technology at the Service of Humans; Silver Economy - Investing for Population Aging and Millennials' Values which are the long-term themes we expect to dominate in the coming years and provide investment opportunities. These themes, based on our House View, provide a tangible link between today's major developments and investors' portfolios and can improve portfolios' risk/return profile in the long run.
The two supertrends we find compelling are:
Trend 1: Angry Societies - Multipolar World
Since the financial crisis of 2008, inequalities have grown, not so much across countries but within them, and especially in the developed world. Tough labour market conditions following the economic recession were exacerbated by hyperglobalisation and disruptive technologies. This combination left many middle-class households permanently worse off after the crisis. Furthermore, that same middle class grew more and more frustrated about the inability of the political establishment to deal with key problems such as migration and the rise of terrorism.
This led citizens across the developed world to mobilise to drive political change, the results of which have become increasingly apparent. Newly elected governments have strong popular mandates. Therefore, the next four to seven years are likely to bring about economic policy measures aimed at appeasing the Western middle class in the developed markets.
In this context, we identify three investment opportunities which should benefit from these economic policies.
i) Security and defence: The new governments are likely to strive to restore the prosperity of the middle class, invest in national security and defence, and stimulate private consumption.
Consequently, investors can expect sectors and companies that benefit from such policies to see an upswing in sales, revenues and market valuations.
Defence companies are major recipients of government grants and vectors of job creation. Additionally, defence spending is likely to increase as geopolitical uncertainties and tensions between military heavyweights rise.
ii) National champions and brands: These companies can benefit from government incentives to build factories at home or a reduction or suspension of corporate taxes if they invest domestically. Such large companies have an inherent multiplier effect that politicians can use to drive their agenda. National champions further employ a large workforce in their home market. This reduces their vulnerability to protectionist measures and dependence on globally integrated manufacturing processes. Businesses likely to create jobs for low-skilled workers (general and IT manufacturing, construction, telecom equipment) are strategically important.
iii) Emerging market consumers: Emerging markets (EM) have a powerful domestic growth driver in their own consumers (with more upside in terms of exposure to international trade), who are increasingly more attracted to domestically produced items, and spend more on health, fitness and beauty. We expect EM domestic travel and holiday providers, selected domestic auto, pharma and consumer brands and e-commerce companies, international fashion, personal care, quality food and sportswear companies to benefit from strong domestic demand.
Trend 2: Technology at the Service of Humans
Although technology has come to be seen as a threat that could make manpower redundant, we believe the expansion of digitalisation into almost all areas of life (smart homes, smart industries, smart cities) provides more positive than negative aspects for people. It provides solutions to existing challenges, for instance reducing energy consumption, improving traffic flow or increasing crop yields. There are plenty of cases where technology is, in fact, at the service of people.
Two markets that we believe will benefit most from the progress in IT are automation and virtual & augmented reality (VR/AR).
The automation market includes the trend towards smart homes, smart industries and smart cities. Beneficiaries are vendors of robots, providers of factory automation software, IT companies that offer the processing power and management of data or companies that focus on maintenance and utilisation of plants and machines. Self-driving cars, delivery systems via drones or robots and warehousing automation are other examples.
In our view, the VR/AR market is the eighth mass media market that could become as large as the smartphone market (the seventh mass media market, US$600-700 billion) in the next 10 years. Opportunities to grow can be found in the hardware, software and e-commerce space, going from a focus on gaming (2015-2018) to a focus on interaction (2018-2023) and later on e-commerce services (2023-2030).
Beneficiaries are mainly companies that offer gaming hardware and services platforms, semiconductor firms that provide the processing power/data management and online advertisers and commerce platform providers.
Traditionally, the healthcare industry is slow to embrace change, but this time feels different. With the emergence of remote patient monitoring solutions, telehealth offerings and the fact that health education and health management portals are gaining traction, digital health is visibly reshaping the current standard of care.
Remote monitoring strikes us as the area that provides the highest value-added given its utility in managing chronic diseases. Considering that an estimated one-third of total US healthcare spending goes to the management of chronic diseases, the savings potential that remote monitoring offers becomes evident. Further, the provision of medical advice at a distance can also be a great cost-saver, with theoretical savings in the US alone estimated at US$30 billion, and bring healthcare to remote areas.
Cesar Perez Ruiz: We see five key themes for the coming five to 10 years.
The first is innovation. We think a major wave of radical innovation is under way and is going to dramatically reshape the economy. Investors should focus on seven areas: the Internet, IT and data processing, automation, transport, new energy, life sciences and smart materials. These are best approached in a top-down way initially, to identify the thematics you want to invest in, then using active management to identify the most promising companies in those areas and to ensure that these are played effectively.
Another major theme will be emerging markets. They have had a bumpy ride over the past few years, but the long-term fundamentals supporting the rise of EM remain in place: demographics and the EM consumer.
Population growth globally in the coming decade will take place almost entirely in EM, and EM consumption growth could be five times that of DM (developed markets). In the short term, EMs look exposed to Fed tightening, a potential rebound in the dollar, and, for equities, to a closing of the earnings gap with DM.
Risk also remains higher in EM in general. So for now it still makes more sense for risk-averse investors to play EM through DM - investing in DM multinationals with a large EM footprint.
In the longer term, as EM shifts away from export-dependence and towards domestic-demand-driven growth, we see strategic opportunities in EM consumer sectors in particular - but a lot of the large local players in EM consumer staples are privately owned, and the weighting of consumer firms in EM benchmark indices is pretty low. So investing in large multinationals with a significant share of EM revenue (40-60 per cent for some big players) could make the most sense over the longer term too.
Disruptive M&A (merger and acquisition) is set to be another big theme. M&A had some lean years after the last crisis as financing was tight and companies were hoarding cash, but it has picked up strongly this year. It had already recovered in the US, but now Europe is joining the party as economic growth picks up and corporate confidence recovers.
M&A volume in western Europe jumped to US$846 billion in January-May this year, up 196 per cent year-on-year, and volume in the US rose to US$1.1 trillion, up 34 per cent. The key change though will be the increasing role for disruptive M&A, as innovative new giants buy up traditional players to get footholds in sectors they want to conquer, and put pressure on the other incumbents.
Amazon's recent purchase of Whole Foods is a case in point - share prices of other companies in the sector went down on the news, because of fears that competition from Amazon will squeeze prices. Good bottom-up stock picking will be important to identify the winners and losers.
Hedge funds will also benefit - through pure merger arbitrage plays, multi-strategy event-driven books or traditional long/short equity positioning. Activist investors are muscling in - Third Point's acquisition of a US$3.5 billion stake in Nestlé is a case in point, and heralds further disruption for traditional European players.
Private equity is also getting in on the act, offering a longer-term way to play the trend. CVC Capital Partners, a European buyout firm, raised a record 16 billion euros (S$25.1 billion) this year, benefiting from demand among investors for the very attractive returns from leveraged buyouts.
Policy normalisation by central banks could be a real game changer. Supportive central bank polices have played a big part in keeping volatility in financial markets low in recent years, but central banks are set to turn less supportive. The Fed has already started to tighten - its next big step will be to start to run down its balance sheet late this year - and although the ECB (European Central Bank) is further behind in the policy cycle, we think it will taper asset purchases next year. It might even raise rates if German inflation picks up.
Volatility is likely to rise as policy support is gradually withdrawn - we have already seen some flickers - and correlations across assets will fall. That will create opportunities for tactical trading, and will also mean a comeback for active managers and hedge funds - they have already been benefiting this year. Long/short equity should do a lot better in that environment, for example, and we also like global macro.
Deregulation will also be a big theme for certain sectors in the US. On banks, the pendulum is swinging back towards less regulation, reversing some of the knee-jerk responses that followed the financial crisis as their costs become apparent.
There have already been several dozen regulations undoing aspects of Dodd-Frank, for example. This is good news for US banks, alongside rising rates - and considering that their capitalisation is strong and valuations are pretty neutral. Deregulation also looks to be on the cards for biotech, with the FDA (Food and Drug Administration) in the Trump administration's sights.
Johan Jooste: Throughout history, the world has been shaped by the confluence of major economic, social and political forces. These mega trends are typically long term in nature with profound economic ramifications.
At the heart of mega trends is demographics. The world's population has more than doubled in the past 40 years to almost seven billion and will grow another 50 per cent by 2050. More importantly, a growing part of the population will live in urban areas, making urbanisation one of the most profound trends in the years to come.
Medical advances have enabled people to live longer. However, falling fertility rates have resulted in declining working populations, putting serious strain on economic growth.
Trend 1: Urbanisation - entering into the golden age
In the next decade, the proportion of urban population is expected to reach two-thirds. The global urban population has been rising by an average of 65 million people annually in the past three decades, the equivalent of adding seven Chicagos a year, every year. As population growth puts more pressure on the cities, infrastructure spending will more than double to US$9 trillion per year for the next decade.
Trend 2: Disruptive technology
The next disruptive force is the acceleration in the scope, scale and economic impact of technology. Technology can create significant disinflationary pressures, increase price discovery, reduce labour costs and create operational efficiencies. It also differentiates losers and winners. Technology offers the promise of economic progress in emerging economies at a speed that would have been unimaginable without the mobile Internet.
Trend 3: Timeless need for healthcare
The world's population is expected to increase by one billion people in the next decade. Of that billion, more than 500 million will be people aged 60 or older, as life expectancy around the globe continues to rise. The ageing situation is going to be more acute in Europe, Japan and the US. More healthcare resources and service innovation is needed globally to deliver the long-term care and chronic disease management services required by a rapidly increasing ageing population. The middle class is growing and with urbanisation accelerating, people are adopting a more sedentary lifestyle. This is pushing obesity rates and cases of diseases such as diabetes upward.
Thematic investing rewards investors with a long-term investment horizon because it seeks to capitalise on the secular trends influencing our world and because it is an approach that looks beyond the volatile and unpredictable swings in the economic cycle. However, getting the timing right and finding the correct investment vehicles is not always straightforward.
Using purely quantitative methods to identify themes and companies is not an effective approach and automated screening processes do not work because of how subjective it is to categorise how a sector or company can benefit from a mega trend.
Take disruptive technology as an example. Bank of Singapore and Morningstar created a robust framework to identify companies, employing a fundamental and bottom-up approach. The system uses a systematic approach and relies on the deep understanding of each company's fundamentals by over 100 equity analysts. We identified key themes - such as robotics, Big Data, 3D printing, among others - in innovation and assessed each company's (from over 1,400 companies) exposure to them.
Understandably, most investors will have difficulty undertaking the laborious work of doing company-by-company analysis. Hence, investors may consider employing the skills of an active fund manager with the track record to select stocks that provide exposure to a particular theme. Others may want to consider an index approach, investing in funds that offer exposure to themes by tracking specially-constructed indices - an investment option that has only emerged relatively recently. W