Institutional investors are preparing for a bumpy return risk space where volatility is higher for all assets and real returns are much lower than what has been the norm over the past 10 years, said Robertas Stancikas, a senior research associate of institutional solutions at AllianceBernstein, during the Canadian Investment Review‘s 2023 Investment Innovation Conference in November.
“But in the new regime, equities will still continue to play a core role in any investment portfolio. In our view, this is the most accessible and liquid real asset that you can get exposure to.”
Three forces are collaboratively working to drive higher inflation, lower growth and lower corporate margins: de-globalization, demographics — particularly the rapidly aging population — and climate and social issues.
Read: How is de-globalization affecting institutional investors?
Indeed, de-globalization reduces growth through reduction in trade and accessible markets and leads to less knowledge transfer across borders, which also impacts productivity, said Stancikas, noting companies will need to maintain higher inventory levels, which hurt margins. The declining population of working-age individuals is expected to reduce the available number of workers and increase the need for social care for an ageing population. Climate change has a direct impact on land use and extreme natural events will, over the long run, result in increased insurance costs. These elements drive political uncertainty in terms of migration, geopolitical tensions and competition for resources, making companies reluctant to invest in periods of uncertainty.
The same three forces are driving inflation higher, he said, noting de-globalization reduces the amount of labour sourced across borders and empowers workers to ask for higher wages, which feed through to higher inflation. While the energy transition will eventually lead to lower energy prices, the cost to make that transition will contribute to inflation in the short term.
Read: Study finds institutional investors are most concerned about geopolitics and inflation
“Our conclusion is that . . . inflation is going to be structurally higher than what we’ve been used to over the last 20 years, but not out of control.”
In this new investment regime, Stancikas said it’s important for institutional investors to find other assets to replace the role that bonds are playing, whether they’re long-short factors across the fixed income and equity space or commodities like gold, which have a long history of delivering real return. They could also gravitate toward real assets, such as farmland or timberland.
As long as inflation isn’t out of control and not above four per cent, equities can still deliver real earnings and real positive returns, said Stancikas. “We think that instead of focusing on 60/40, 70/30 or any combinations of stocks and bonds, [investors] should be sourcing returns from different sources [of] return streams.”
He suggested they focus on generating idiosyncratic alpha by market timing, investing in themes and portfolio construction through combining factors and stock selection. “We think the future of asset allocation is active and diverse, including sources of idiosyncratic alpha, factors and real assets.”
However, equities will remain a core part of investment portfolios with moderate inflation and real rates remaining low in the long-term historical context, he said. “We believe that significant shifts in portfolio allocation are still to come . . . and . . . investors [will] need to rethink their approach to strategic asset allocation. . . in this new investment regime.”
Read more coverage of the 2023 Investment Innovation Conference.