CLIMATE-CHANGE issues will affect everything from asset-class dynamics to strategic asset allocation and investing styles, said Pictet Wealth Management in its 2021 edition of Horizon - an annual publication that details its 10-year view on economies, expected returns and strategic asset allocation.
It has noted how governments and central banks around the world are steadily integrating climate-change issues into their policy making; such developments will present both opportunities as well as challenges.
In this environment, Pictet is advocating an asset-allocation strategy that moves away from a classic 60:40 portfolio - where 60 per cent of one's portfolio is focused on equities, with the other 40 per cent on bonds - and one that moves towards endowment-style investing, that is, the multi-asset approach adopted by endowment funds.
"Climate change will be one of the most important externalities hanging over economies and markets," said Christophe Donay, head of Asset Allocation and Macro Research at Pictet Wealth Management.
On the plus side, adapting economic policies to deal with climate issues could boost countries' growth and productivity, presenting opportunities for innovation in policy and in technology. Climate mitigation measures are likely to have a particularly positive impact on the growth trajectory of Europe and to a lesser extent in China, over the next 10 years, Pictet said.
But climate mitigation measures will have their costs as well.
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"As these are internalised into production processes and consumption patterns to transition to a low-carbon economy, they will impose higher costs on third parties, contributing to higher inflation by a projected 10 basis points per year over the next 10 years in major economies," Mr Donay said.
"A classic 60:40 portfolio may be suboptimal at times of higher inflation. From a strategic asset allocation perspective, the expected rise in inflationary pressure, in part because of energy-transition policies (due to the pressure to reduce carbon usage and emissions) over the next 10 years, is a further argument in favour of endowment-style investing, which include a range of real assets - private equity infrastructure, real estate, commodities and gold - that may protect against inflation."
In the next 10 years, Pictet expects real returns from cash to remain negative, no thanks to the rise in inflation, along with low interest rates - as central banks around the world keep short and long-term interest rates low over the next decade, to promote climate investments.
The low interest rates will also mean that government bonds will continue to provide poor returns, even though core bonds should maintain their reputation for protecting portfolios.
Pictet expects equity returns to decline, as carbon levies of one sort or another hurt corporate margins. It's also noted that increasingly stretched valuations have impacted its return expectations for developed and emerging-market equities alike.
But, private equity should continue to deliver highly attractive returns over the next 10 years, in exchange for a large degree of illiquidity. Of the 50 asset classes covered in Horizon, Pictet said its return expectations are highest for venture capital and private equity.
It is also advocating the inclusion of real assets in strategic asset allocations, as infrastructure, real estate and commodities are among the most effective inflation hedges.
On a macro level, Pictet expects global growth to remain solid in the next decade - as policymakers increasingly come to grips with climate-change issues, while innovation continues to spread through economies - and for Asia's significance to rise.
Dong Chen, senior Asia economist at Pictet Wealth Management, said: "Asia's economic importance will likely become even more significant in the current decade.
"We expect Asia's (ex-Japan) annual GDP (gross domestic product) to grow at 4.2 per cent by 2031 and account for an even greater share of world GDP over the next 10 years."
And, as China continues to register strong economic growth and progressively opens its financial markets, it makes increasing sense to consider Chinese assets for inclusion in strategic asset allocations, Pictet said.
Pictet Wealth Management is the wealth management arm of the Geneva-based Pictet Group, with US$703 billion in assets under management or custody, as at March 31, 2021. The group has 30 offices worldwide, including one in Singapore.
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