As the world enters a period of economic recovery, some fundamental shifts in the investment landscape are becoming apparent. Traditional correlations between asset classes, and the roles of asset classes within portfolios, are being challenged. Meanwhile, diversifying assets, such as private markets investments, have become accessible to a wider range of investors. This has created opportunities but has also added complexity and enhanced the need for specialized investment research expertise.
Central banks are grappling with the dilemma of inflation, which re-emerged in the wake of the pandemic. While some inflation is expected during any recovery, there is much debate as to how transitory this phase will be. This has raised the likelihood that inflation hedges will be required in client portfolios. China’s rise to become a global economic superpower was not thrown off course by the pandemic. Its influence in Southeast Asia and beyond continues to grow and its ascent should not be ignored by investors seeking to build diversified portfolios.
Finally, dire warnings from scientists and global organizations have focused investors’ minds on the impacts of climate change. Comprehensive action is needed to help protect portfolios against climate risks. Financial intermediaries and their clients need to be adaptable to the challenges that lie ahead. We have identified five areas for advisors to consider – areas we believe are critical for long-term success.
Following the global financial crisis, “traditional” balanced portfolios, made up of 60% equities and 40% fixed-income assets, and outpaced more diversified portfolios. However, we believe that sustained low interest rates, inflationary pressures and high equity valuations will continue to reduce forward-looking return expectations for client portfolios. This means that investors can no longer rely on past stock/bond performance.
With global inflation on the rise, the possibility of higher interest rates is becoming more likely. Client portfolios may therefore be challenged if the historical diversification benefits of fixed-income allocations no longer hold true. Higher inflation and rising interest rates may have a negative impact on both equity and fixed-income portfolios. The past few years have seen many investors sacrificing investment quality while seeking higher-yielding instruments. Moving forward, advisors need to be more mindful of the hidden risks involved in seeking yield, and should focus on the future role that fixed-income allocations could play in client portfolios.
China’s rapidly diversifying and consumption-led economy is significantly under-represented in standard indices and in many investors’ portfolios, including those with a broad allocation to emerging markets. For historical reasons, headline exposure to China in emerging market equity indices is heavily tilted toward offshore Chinese equities. This overlooks the fact that the future dynamics of China’s economy will be increasingly reflected in its onshore equity market (commonly referred to as China A-shares). China presents investors with a range of compelling opportunities. Given its scale and growing global influence, we believe it warrants dedicated strategic, risk-aware allocations in well-diversified portfolios.
For the first time in a generation, investors need to seriously consider the impact of inflation. It has been on a gradual downward trend for almost 30 years – but this cannot last forever. Although some disinflationary pressures remain, several factors have shifted in the past 18 months: There has been a slowdown in globalization due to the COVID-19 pandemic, a change that has been coupled with large government spending programs and with central banks loosening their price-stability targets. It is not known whether 2021’s inflation surge is transitory or not. However, compared to the pre-pandemic period, the risk of structurally higher inflation, and a more volatile inflationary environment, has increased. While the Federal Reserve, and other major central banks, believe the current rise in inflation is transitory and that inflation will fall back to normal levels, historically inflation has been difficult to predict. Moreover, the range of potential inflation scenarios in the future has increased. Given these factors, we believe scenario analysis that takes the risk of higher inflation into account is vital, as it can provide investors with crucial insight into the impact of inflation on various portfolio constructs.
In recent years, demand for sustainable investment products has increased dramatically. This has been driven by a variety of regulatory and societal pressures. Environmental concerns and diversity, equity and inclusion (DEI) issues have become critical topics that are influencing corporate agendas. This means investors now have a wide range of new risks and opportunities to factor into their portfolio allocations. The increasing significance of environmental, social and governance (ESG) factors means that the next decade may be a transformational period, as these criteria influence and change the world. Product manufacturers have already responded with the rapid launch or restructuring of a vast range of ESG funds. This acceleration in supply presents investors with an additional challenge: distinguishing between products that genuinely integrate sustainable investing principles, and those that only demonstrate a superficial support.
Building sustainable investing policies at a firm level is important. Such policies can provide financial intermediaries with more robust governance frameworks, which can then help them make decisions on sustainable allocations. Flexible investment approaches can bring additional sources of return and help achieve better client outcomes.
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