Emerging from the calm. Building portfolio resilience in a world of changing risks

03 May 2023

Emerging from the calm

Building portfolio resilience in a world of changing risks

In a fast-fragmenting world, concern about geo-political instability has risen from a peripheral emerging market concern to a ‘centre-stage’ issue for the global economy. The International Monetary Fund recently reported that rising geo-political tensions and the fragmentation of the global economy have intensified in recent years and warned of the threat these risks pose to financial stability and asset prices. 

As a new world order takes shape and geo-political blocs emerge, businesses are now more exposed than ever. Companies have become more global both in terms of where they are located, and also due to more complex supply chains. In this environment, investors will need to grapple with what this means for their investments and how they can build resilience into portfolios.

At our latest Symposium, held in April 2023, former Deputy Prime Minister of Australia, John Anderson AC, discussed the outlook for the geo-political environment, the implications for Australia, and some of the ways we can navigate these challenges as we emerge from 80 years of geo-political calm.

John Anderson was joined by Scott Haslem, Chief Investment Officer at LGT Crestone Wealth Management, Amanda MacDonald, Head of Sustainable Investment at LGT Crestone Wealth Management, Rob Mead, Head of Australia, Co-Head of Asia-Pacific Portfolio Management at PIMCO, and Frances Lim, Head of Asia Pacific Macro at KKR.

The discussion was moderated by Clark Morgan, Vice Chairman and Head of Strategy and Development at LGT Crestone Wealth Management.

John Anderson AC, Former Deputy Prime Minister of Australia

Tackling geo-political risk

Over the past few decades, Australia has enjoyed a period of not only geo-political calm, but also one of immense opportunity. John Anderson explained that, through the ages, civilisations have been fuelled by a common commitment. Going forward, one of the greatest risks to Australia will be polarisation within the community, which will create challenges in finding consensus for economic reform.

“The greatest challenge for our society is that we have lost confidence in ourselves. Clear, critical thinking is needed about the issues that confront us.”

While it is difficult to know exactly what will happen in our region, Anderson acknowledged there may be conflict in the coming years. He sees four major flashpoints, which involve the governments of Russia, Iran, North Korea, and China. 

To successfully navigate these risks will require international co-ordination. Positively, sanctions against Russia have been well co-ordinated, and this has sent a message that Western nations still have intent, as well as capability. We have also seen increased co-operation of countries such as India, Japan, Australia, South Korea, the Philippines, and the US, who recognise the need to preserve stability in our region.

In meeting the challenges of a changing world, Anderson also emphasised the need for Australia to step up in the technology race and invest in education. 

“We need to invest in education, grapple with the affordability of housing, and rebuild a constituency of economic reform.”

Frances Lim, Head of Asia Pacific Macro KKR

Inflation will have a higher resting heartbeat

As the world emerges from 80 years of geo-political calm, markets are expected to be more volatile and cycles will likely be shorter. Our panellists discussed the importance of ensuring portfolios are fully diversified in this environment, and highlighted the need to seek out structural thematics that will help drive long-term returns and weather any short-term periods of underperformance.

Although markets are expected to stabilise in the second half of this year as central banks pause, it is unlikely we will be returning to a ‘normal’ environment. Scott Haslem explained that the ‘new normal’ will require investors to think differently about portfolios. Geo-political tensions will likely increase, inflation will have a higher resting heartbeat, and it is improbable that central banks will reduce rates back to zero-bound levels any time soon. 

“There will be challenges ahead, whether that’s ‘sticky’ inflation or difficult geo-political situations, and this calls for a new way of thinking about how we manage portfolios.”

Rob Mead, Head of Australia, Co-Head of Asia-Pacific Portfolio Management PIMCO

Unpacking the impact of inflation and what this means for investors’ portfolios, Rob Mead explained that the move from a world of ‘transitory’ inflation to one of ‘sticky’ inflation has been a really important change for markets. 

Haslem explained that in a world of higher inflation, it will be hard for investors to find a beta trend in equities and simply ride this out. Structural themes, such as the energy transition and sustainable investing, should provide a safe haven for investors, and private markets are expected to play an increasingly important role in portfolios. In Australia, defensive stocks, like healthcare and consumer staples, should perform better in this environment, and ‘dividend aristocrats’ (i.e., companies with a long-term track record of increasing their dividends) will be preferred. 

"Breakage does not mean financial crisis. Breakage means isolated areas where the most vulnerable institutions don't have a long-term future."

Rob Mead
Head of Australia, Co-Head of Asia-Pacific Portfolio Management PIMCO

Are things about to break?

In a bid to tackle soaring inflation, central banks around the world have aggressively raised interest rates over the past year. The pace of interest rate hikes is faster than at any time in recent history, and on 10 March, something broke. Silicon Valley Bank was the first institution to fail, followed by Signature Bank, before regulators managed the sale of Credit Suisse to UBS. While the speed of the collapse of each of these institutions was frightening, Mead explained that this does not mean we are on the cusp of a financial crisis. 

‘Breakage does not mean financial crisis. Breakage means isolated areas where the most vulnerable institutions don’t have a long-term future.” 

Although the venture ecosystem drew much attention in the demise of Silicon Valley Bank, Frances Lim explained that the event was ultimately a banking sector issue. Over the long term, the venture ecosystem will still play an important role in fuelling the innovation needed to modernise the energy system and meet the collective goals of climate change.

“We expect to see capital continue to flow into VC and growth equity, so we can find the solutions for the future that will address the problems of today.”

Scott Haslem, Chief Investment Officer LGT Crestone

Opportunities in the energy transition are endless

Finding solutions to address the problems associated with climate change will unearth opportunities across multiple asset classes. Amanda MacDonald explained that the cost curves of renewable energy sources have already begun to fall and are now more in line with cheap fossil fuels. This has made renewables as an asset class more attractive, and the opportunities are now endless. However, MacDonald also explained that if we are to successfully reduce our reliance on fossil fuels, then we must do so by means of a ‘just’ transition. 

“We don’t want to be moving to alternative energy sources that are more expensive and plunging large portions of the population into poverty, as this will not have a beneficial societal outcome."

Amanda MacDonald, Head of Sustainable Investment LGT Crestone

For now…expect a slowdown in 2023

As monetary policy acts with a lag, and its full effects are yet to be felt by the economy, it is likely that global growth will slow in 2023 to around 2%. Adding to this, tightening credit conditions will also likely weigh on activity, placing the economy in a near-recessionary camp. To avoid a severe downturn, Haslem explained that we will need to see inflation fall, otherwise central banks will likely tighten again and force us into a recession. 

Clark Morgan, Vice Chairman and Head of Strategy and Development LGT Crestone

Valuations in equity markets have already adjusted partially to reflect the expected slowdown. And while there are still headwinds that equity markets need to navigate, we are now beginning to see some tailwinds emerge, such as a potential pause in interest rate rises, as well as bond yields. At LGT Crestone, we are more constructive on markets than we were in 2022, but we retain a marginally underweight tactical position in equities. Recognising that we are now 17 months into the current bear market (the average length of a bear market is 12 months), it is important to remain exposed to a potential market rally. But we prefer some better valued non-US markets, such as Australia and emerging markets, due to attractive valuations (on a relative basis) in Australia and China.

Read more about dividend aristocrats in our article The search for sustainable yield , and find out how Australia can benefit from the energy transition in Australia’s next mining boom? The role of critical minerals in renewable energy.

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