In the wake of Russia’s invasion of Ukraine, institutional investors are increasingly factoring geopolitical risks into portfolio construction, according to John Bai, senior vice-president and chief investment officer at NEI Investments, during a 2023 economic outlook seminar hosted by the Canadian Pension and Benefits Institute on Wednesday.
“All of a sudden, geopolitical risks went from the realm of noise to [having a] real portfolio impact,” he said, adding another major consideration is whether China will invade Taiwan.
Also speaking at the event, Aaron Bennett, chief investment officer at the University Pension Plan, noted a shift in China’s role in the global market. “It’s unclear if that’s necessarily going to make it more investable or less investable. But I think it’s no longer a factory for the world — it plays a very different role and . . . it appears it’s going to be managed in a different way, with greater government intervention.”
Read: 2022 Top 40 Money Managers Report: Geopolitics roaring back into focus for institutional investors
The Chinese government is now focusing on economic growth, said Tanya Lai, managing director of public markets at the Investment Management Corp. of Ontario. “We’re in an environment where Chinese consumers have around US$2 trillion in their savings waiting to be unleashed on revenge spending. We’ve been tapered by inflation, but they haven’t.”
In addition to geopolitical risk, institutional investors are also considering the potential impact of inflation on western economies. Michael Mullaney, director of global markets research at Boston Partners Global Investors Inc., said a recession isn’t on the immediate horizon but could happen towards the end of the year or in early 2024.
He cited several factors that often predict imminent recessions, including an inverted yield curve and a drop in the real money supply. “We look at 28 different combinations of various points in the yield curve to see which parts are inverted right now. Currently, out of those 28 [points], 78 per cent of them are inverted right now. Usually, the demarcation line for recession is 50 per cent.”
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Both Bennett and Lai said managing liquidity has become increasingly difficult. “Managing liquidity is critically important because we do have a liability and benefits we need to pay out,” said Bennett. “But also, from an investment perspective, you want to be in a position where you can do the right thing at the right time. You don’t want to sell assets at the bottom to fund benefits [or hit] secondary private markets with a bunch of fully-invested funds.”
“At the peak of [the coronavirus pandemic] in 2020 we saw the average equity mandate cost go up to 50 basis points,” said Lai. “It has come down a lot, but it’s still hovering around the average of 23 basis points in terms of transacting your portfolio.”
All panellists agreed a balanced 60/40 portfolio is the preferred approach for 2023. “As we head into 2023, we’re expecting a little more volatility on the economic front, but real rates have reset to a point where I think they can start to provide that balance for a 60/40 portfolio,” said Bai.
“[If you look] at the S&P 500 market, it goes up 72 per cent of the time,” said Mullaney. “If you went to [Las] Vegas and found a table that paid off 72 per cent of the time, you’d never leave.”
Read: Balancing liquidity and the search for yield at U.S. public pension funds