Last year offered up one of most tempestuous investment environments in recent memory, and this year looks to be equally dynamic.

It will be increasingly important for pension investment committees to be proactive and flexible in the management and oversight of their portfolios. Those that can quickly assess and respond to fundamental economic shifts will better protect their portfolios, and those that don’t will lag.

Here are six factors that may present challenges and opportunities for investment committees in 2021.

  1. A low growth environment

The pandemic has significantly impaired global economies, causing a sharp spike in bankruptcies and in unemployment rates around the world. Despite globally coordinated government measures, which included fiscal stimulus packages and accommodative monetary policies to lower interest rates, slower economic growth levels are expected over the next few years. Lower GDP growth will mean muted corporate earnings levels, which will translate into lower expected equity market returns. Given that most portfolios rely on equities as a growth driver, this will mean lower expected total portfolio returns.

  1. Higher volatility

We can expect continued elevated equity market volatility as investors react to positive and negative news about the pandemic and its spread. This includes information on global vaccine rollout progress and the effectiveness of those vaccinations. Market gyrations can rapidly shift the asset mix of a portfolio, enhancing the importance of rebalancing practices. For example, plans that rebalanced their portfolios after the initial COVID-19 equity market correction enhanced portfolio returns in 2020 by as much as two per cent.

  1. Secular shifts in the economy

The pandemic created new trends and accelerated existing ones. The first wave caused a large drop in demand for travel, restaurant dining, construction and in-person entertainment. At the same time, demand for automobiles and recreational vehicles spiked, as people looked for ways to avoid public transportation. Some of these trends are expected to reverse as the gravity of the pandemic recedes.

The pandemic greatly accelerated what had been a gradual shift away from in-person shopping towards online retail over the last several years. This trend will likely be permanent. Similarly, companies have been experimenting with remote workers for some time. However, pandemic closures forced most employers to quickly implement infrastructure to support remote employment for the majority of their workforce, creating a sharp demand for cloud services and software to facilitate remote employment and office interconnectivity. When the pandemic ends, we can expect these workforce changes to endure, as companies now have quickly built the required infrastructure and will ultimately achieve greater cost savings from a lower brick and mortar footprint.

This type of environment requires portfolio managers to be nimble, so they can adapt their portfolios to a rapidly changing environment. They must also be able to distinguish between short-term impacts, which will reverse when the worst of the pandemic passes, and permanent economic shifts.

  1. Strategies for alternative asset classes

COVID-19 negatively affected real asset portfolios. Publicly traded real estate and infrastructure stocks experienced significant corrections. While we didn’t see the same magnitude of correction with direct-held portfolios, we did see some reduction in portfolio values. At the same time, liquidity restrictions were imposed on some real estate portfolios, due to concerns over valuation levels and liquidity.

As with equities, we must distinguish between short-term volatility and permanent impairment. In the case of infrastructure funds, we saw a short-term drop in asset pricing as a result of a short-term drop in usage for these assets due to the lockdown. Over the long run, we see demand for existing infrastructure projects continuing to grow, as there is a critical shortage of these assets around the world. This short-term adjustment can be viewed as an opportunity to acquire these attractive assets at a temporary discount.

In contrast, commercial real estate portfolios may be experiencing permanent impairment. Certain traditional sectors of the commercial real estate market may not recover as quickly, after the pandemic abates. The office sector may face long-term reductions in demand, as remote workplace trends reduce demand and rental rates. Similarly, the retail sector may be permanently impaired, as bankruptcies continue in response to the growth of online shopping. A safer way to invest in real estate may be in the form of commercial mortgage portfolios, where there is no direct ownership in the commercial property. Commercial mortgage portfolios use the properties as collateral on the mortgage loans, maintaining a healthy loan-to-value buffer.

  1. Need to enhance portfolio yield

Pension funds will continue to rely on fixed-income investments for stable and predictable income to fund pension payments. Bonds also help diversify portfolios and control risk. However, expansionary monetary policy has caused bond yields to fall below inflation levels. These low yield levels introduce the risk of capital losses, when global economies stabilize, enabling fixed-income yields to rise.

In this environment, pension plan sponsors must find ways to increase portfolio yields through higher allocations to investment-grade bonds or through small allocations to high-yield bonds, global bonds, mortgages or private debt. At a minimum, this could take the form of a movement from a core to a core-plus bond strategy. Larger funds could achieve this through direct exposure to some of these yield enhancement strategies.

  1. Shift to remote workplaces

Many workplaces, including those housing finance and investment functions, have moved to a remote and online structure. Initially, this abrupt displacement disrupted pension investment committee activities, leading to a slower reaction to certain rapid market changes. Looking ahead, it will become increasingly important for investment committees to quickly evaluate and respond to market shifts and emerging trends. Virtual structures may actually facilitate more regular meetings, as travel is not necessary.

Colin Ripsman is the founder of Elegant Investment Solutions. These views are those of the author and not necessarily those of the Canadian Investment Review.