Traditional methods of defensive investing may not have the desired result in today’s market conditions.
The world has changed and investors may need to look to different ways of investing to diversify their portfolios and buffer against challenges and risks. BT spoke to three leading fund managers Magellan Financial Group, RARE Infrastructure and Pendal Group for their thoughts around the economy and opportunities.
Will there be a recession?
Still smarting from the global financial crisis, investors are highly conscious of the potential for another recession.
The Western economic world has been in a prolonged period of low interest rates and low inflation which looks unlikely to change. Stefan Marcionetti, Portfolio Manager at Magellan Financial Group, says “while the US consumer has remained strong, there are concerns over the EU, Germany and China which are adding to the subdued economic conditions.”
On a domestic level, the Australian economy has been dragged down by falls in housing and construction, along with stagnant wages growth (which has affected discretionary spending).
Mr Marcionetti says, “the conditions we’ve seen leading up to a severe recession in the past aren’t here today. The more significant risk would be an inflation spike because that would force central banks to reverse course on monetary easing”.
Shane Hurst, Portfolio Manager at RARE Infrastructure, agrees with this, saying, “the highly stimulative central bank environment has been enough to hold the economy and reduce the risk of a severe recession.”
While the risk of a recession may be reduced, it has still been a challenging environment for investors, with defensive positions not always having the desire effect.
How to position investments defensively
Traditionally defensive positions have been aligned to interest rates, with fixed income investments popular in more volatile periods. The current environment of low inflation and low interest rates has flipped this, but even defensive styles of equities investing have not necessarily been the right approach.
Chris Adams CFA, Portfolio Specialist at Pendal Group, says, “A-REITs, infrastructure, utilities and consumer staples are traditionally Australian defensive investments but you need to be careful of valuations and the market environment. For example, a lot of A-REITs are in the retail environment which has been struggling and so are not offering the level of protection in a portfolio.”
Further to this, disruption in the form of newer technology or ways of doing things has changed the outlook for companies which might once have been considered blue-chip stocks, like Telstra. Investors are increasingly needing to consider themes like global technology or climate change as part of the future prospects of the companies they invest in.
An example of what this means in terms of the income cycle may mean focusing on companies offering consumer staples like groceries rather than companies offering consumer discretionary goods like fashion (where demand is more affected by economic circumstances and wages growth).
Or alternatively, Mr Hurst says, “infrastructure tends not to be aligned towards the market environment. In challenging times, we skew towards essential services like electricity and water where demand doesn’t necessarily change.”
Finding opportunities for the future
Despite the subdued economic conditions, investors can still find opportunities for future growth in their portfolios.
RARE views renewable energy as offering growth potential in the infrastructure space.
“Cost is coming down both for users and investors, in some cases below traditional energy sources like gas. Wind and solar are a key focus with up to 50% of infrastructure development over the past few years focused on this. It’s still only a small fraction of total energy output so there’s room to grow,” says Mr Hurst.
In connection with this theme, environment, social and governance (ESG) considerations are becoming increasingly important. This is an opportunity for companies to continue to be viable and grow in the future.
Pendal’s Mr Adams says, “A corporate acknowledgement of the impact of ESG issues such as climate change used to be the exception, but it’s now becoming increasingly common as shareholders focus on these issues.”
Could population growth offer investment growth opportunities?
Another opportunity set for investors may evolve through population growth and the associated needs it creates. Rather than considering short term market anomalies, expansion of the population will give rise to structural growth opportunities.
For example, population growth is likely to require a certain level of infrastructure spending.
“There’s a gap of around $15 trillion between the $94 trillion needed for infrastructure needs compared with the current trends of investment1. Governments in emerging markets and Asia in particular can’t rely on private funding and will need to rise to meet the gap. There are opportunities for investors in the spending gap, “ says Mr Hurst.
Another opportunity based on population growth looks at the anticipated growth of the Chinese middle and upper classes.
Analysis by McKinsey indicates that Chinese upper-middle class households will increase by 28% compounded annually between 2018-2025 and are set to contribute to almost two-thirds of global growth in luxury spending2.
Mr Marcionetti says, “This is an opportunity for a range of companies. Luxury brands are particularly well positioned to take advantage of the growth in the affluent Chinese consumer.”
Outside of these growth areas, Mr Adams also sees value in some domestic cyclical stocks, which have underperformed over the last year.
“There are some attractive opportunities in well-run companies which are doing a good job of dealing with a tough environment which are worth considering for the longer term,” Mr Adams says.
Both market conditions and changes in the way the world works have required investors to look beyond traditional defensive investing, with new opportunities to consider. Some investors may find accessing specialist help, be it through advice or the use of investment managers, may help in navigating the current environment and positioning for the future. In any case, taking a long term and adaptive approach will continue to help investors manage changing conditions ahead.
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