SPECIAL PROJECTS
SALES REPRESENTATIVE: ELMARIEMARTIN
WRITER: ALF JAMES should be concerned about how capital is allocated in the real economy. A focus on sustainability in a broad sense will help with this process.
So what are the specific themes and change drivers that our global investment committee has identified?
There are twelve of these, which we place in six groups. The first two themes are associated with imbalances in the global economy:
We are seeing a slow shift of economic power and wealth from the developed countries, particularly North America and Western Europe, towards the developing world, which of course includes South Africa. We expect this trend to continue. It will be assisted by the ending of debt-fuelled growth in these developed economies and their consequent “deleveraging”, which will lead to slower growth in future. At the same time, the expected transition of the Chinese economy from capital investment towards consumer spending will also have major effects on the rest of the world.
Uncertainty and risk aversion in recent years has led to a high demand for “safe” assets. This has sent the prices of developed-world Government bonds soaring – this has been systematically encouraged by governments in recent years via techniques such as “quantitative easing” that keep interest rates artificially low, thereby redistributing wealth from savers to borrowers. This may be leading to misallocation of capital and asset price bubbles – the future returns from some of these safe assets may disappoint, and they are also subject to inflation risk.
The next two themes are associated with population change (demographics):
The world’s population will continue to grow significantly, and nearly all of the growth will be in the developing world (but with some continuing migration to the developed nations). This will be accompanied by further rapid urbanisation, which tends to be associated with higher productivity and GDP growth – but this will also increase pressure on the environment and natural resources.
The demographic profile of developed nations will change and they will face rising “dependency ratios” (the ratio of the non-working-age population to the working-age population) as the growth rate of retirees outpaces that of new entrants into the workforce. To an extent this is also true of China. This will lead to various social strains, discussed further below, but could benefit the profits of companies focusing on health care and related services for the elderly.
Rising living standards as well as population growth have contributed to environmental degradation, which also gives rise to two themes:
Resource scarcity arises when an increasing level of demand faces a finite supply of global resources. This applies not just to extractive commodities (minerals and hydrocarbons) but also to food and fresh water. Our ability to cope with the waste products of economic activity – emissions, heat and physical waste – is also limited. We expect continuing long-term inflation in resource prices, which could limit global growth and also increase the imbalances between the resource-rich and the resource-poor, but we also expect that the demand for resources will be altered through innovation (new technologies and new infrastructure).
Climate change and global warming are real, although the exact part that our carbon emissions play in this process is still not clear. Changing weather patterns may impact significantly on countries’ comparative advantages in agricultural production and susceptibility to extreme weather events. We also expect continued focus on the environmental impact of economic activity, leading to country, industry and business losers (and some winners too).
The next two themes fall under the broad heading of innovation and technology:
Globalisation has undoubtedly benefited from technological change (in telecommunications as well as transportation) and from financial innovation. There have been losers from this process as well as winners – within developed countries, inequality has increased as the working poor have faced competition from foreign nations and from tech- nology. The outlook for further globalisation is cloudy, with the risk of political constraints such as higher trade barriers – this may slow the global economic growth rate.
Conversely, the world will continue to benefit from new technologies and – very importantly – from the greater use of existing technologies in the developing world, driving higher productivity and growth in the developing economies.
Developments in the business world contribute the next two themes:
We expect a greater focus on business sustainability in a wide sense. This includes environmental, social and governance (ESG) issues, but more broadly we believe that, when making capital allocation decisions, investors should look for well-run, well-positioned and adaptive, capital-efficient businesses. These businesses should provide superior riskadjusted returns over the long run.
The way that the benefits of economic growth are shared between the providers of labour (workers) and the providers of capital (investors, property owners, savers, entrepreneurs) may also change, although it is hard to be sure exactly how this will play out, as the supply and demand for both labour and capital are subject to various conflicting pressures. In general, we believe that economies and businesses that can develop and retain talent effectively, and also raise and allocate capital efficiently, will do best.
Finally, two themes fall under the heading of government and public policy:
Governments influence their economies through regulation. We expect a continued increase in financial regulation in the aftermath of the global financial crisis of 200709, and in environmental regulation, aimed at correcting the real or perceived failure of the markets in not reflecting the true environmental costs of economic activity in the prices of goods and services. This will create problems for some businesses and opportunities for others.
In developed markets in particular, inter-generational fairness is becoming a theme of social and political debate, as there is an increasing sense that the next generation will struggle to “foot the bill” for the various entitlements of the current generation, such as state pensions and public health care. Ways will have to be found to ration these entitlements. Ironically, “financial repression” via artificially low interest rates in these countries is already starting to tackle this problem by punishing savers (the older generation) and benefiting borrowers (typically the younger generation).
Pulling these themes together into a coherent picture is a challenge. We expect that in aggregate they will favour developing economies rather than the developed nations, but relative growth rates will be determined by the positioning of an economy (or a business) in relation to the changes that are underway, and by its ability to adapt.
It is important to note some “caveats” about the application of these themes to investment portfolios.
Forecasting is highly imperfect at the best of times. “Point forecasts” of economic variables are certain to be wrong! It is best to recognise this by thinking in terms of ranges of possible outcomes, or trends and directions.
Forecasting is also difficult because the themes identified here will interact with each other in highly complex ways that are hard to predict.
In addition, the global economy and the investment markets are “complex adaptive systems” –systems in which the agents learn and adapt as the system develops.
It may also be easier to apply these themes at the “micro” level when analysing the prospects for a particular firm, rather than when considering the “macro” prospects for the global or regional economies.
Finally, it is particularly important to consider the starting valuation of any asset that one is thinking of investing in, and to ask the question “What is already factored in to the market price?”
The history of the TMT (Technology, Media and Telecommunications) “bubble” of the late 1990s is a textbook example – many of the predictions as to how digital technology and telecommunications would change our world have come true, but the investors who over-paid for shares in over-hyped TMT companies certainly didn’t benefit from this.
This also reminds us that the technological pioneers are not always the ones who are best rewarded – often, the second generation of businesses that take the new technologies and industrialize them successfully do better than the inventors and discoverers. Erich Potgieter, Towers Watson
August 2013