A thick fog is clouding institutional investors’ efforts to gain clarity on the global market outlook, but certain key themes are peeking through, according to Manulife Investment Management’s mid-year report.

Geopolitical unrest continues to be a cause for concern, the report noted. The escalation of trade tensions between the U.S. and China could point to a longer period of conflict than investors had previously predicted. And while China appears to have stabilized through government stimulus spending, the report said that stability isn’t likely to be much help in pushing global markets forward.

Meanwhile, investors are once again closely watching the U.S. Federal Reserve. Broadly, markets anticipate three rate cuts over the next 18 months. While Manulife noted it doesn’t quite anticipate such aggressive action, it said weaker data as a result of ongoing trade skirmishes could enflame the situation.

Read: Are tensions between China and the U.S at trade war level yet?

“The global economy and markets continue to experience volatility and trend toward risk aversion,” said Christopher Conkey, head of public markets at Manulife Investment Management, in a press release. “Despite the uncertainty and a short supply of broad-based growth, we see durable public markets opportunities in the second half of the year, including global equities and emerging markets debt. At the same time, we believe investors should consider the potential benefit of longer-term investment disciplines, such as liability-driven and sustainable investment strategies to ensure they are positioned in a way that may benefit their portfolios through market cycles.”

Looking ahead, the report highlighted other major themes institutional investors will be watching with interest in the coming months. As the investment cycle matures, more capital is being deployed in alternative ways, putting the focus on infrastructure, the report said. As a hybrid asset, infrastructure allows investors to seek exposure to the benefits of a number of other asset classes, including fixed income, real estate a private equity.

Read: How infrastructure disruption is shifting investor mindsets

In seeking suitable investment opportunities, investors should avoid what the report calls “trophy assets,” which they have the potential to overpay for. Underwriting and price discipline are key, especially in a late-cycle environment. “Our analysis points to an alarming prevalence of poorly structured deals relying on overly optimistic assumptions that are unlikely to perform as investors expect,” the report noted. “For example, certain toll roads encountered financial trouble after experiencing sharp drops in traffic during the 2007/2008 global financial crisis, ultimately demonstrating far more sensitivity to economic downturn than investors had expected.”

Another theme was sustainable investing with specific attention to climate change. Globally, the growing knowledge about the impacts of climate change and its associated risks is changing how asset managers view investment risk, especially where their fiduciary duty to clients is concerned, the report said. “The concept of fiduciary duty hasn’t yet, under most legal regimes, formally incorporated climate risk management.  However, the concept is set to be tested by legislators and courts, as there’s now, arguably, sufficient evidence available to support the idea that forward-looking climate risk analysis is an integral part of understanding the true scope of asset and investment risk.”

Read: How behind are investors on climate change?

While climate risk can be analyzed on a local level, its effects will be highly localized, material and with the potential to worsen over time, the report noted.

The credit cycle, which is currently in a lengthy expansion phase, was another key theme in the market outlook, with the report identifying the risks — primarily political — that could push the cycle into its downturn. While the tariffs could do a limited amount of damage to the U.S. and Chinese economies, it noted stock markets are moving wildly in their efforts to keep up with the latest comments from political leaders. The longer equity markets remain firmly risk-off, the higher the likelihood of a real material economic impact to the U.S.

Even so, Manulife said it believes the credit cycle has some room to run. Behind that opinion is the fact that high yield spreads are thinner than average, with defaults also below their 20-year average and projected to drop further still.

Read: ESG, China considerations holding fixed income investor interest: survey

Copyright © 2019 Transcontinental Media G.P. Originally published on benefitscanada.com

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