2021 was a remarkable year for US financial assets. US equities returned an eye-popping 28.7%, extending their gains since the trough of the global financial crisis to 812%—an outperformance of more than 500 percentage points relative to non-US developed and emerging market equities.
In Year Ahead 2021, we said we expected the wide availability of vaccines to put Europe and North America on the path to a sustainable recovery, and this bore out. Economic growth and corporate earnings both exceeded our expectations. Developed economies are poised to grow 4.9% this year, versus our estimate of 4.2%, and S&P 500 earnings are on track to expand by more than 45%, surpassing our expectation of a 22% year-over-year growth for 2021. GDP growth in China also exceeded expectations, albeit by a lesser margin.
We said that we expected stocks to move higher in 2021, and the Aura is up 16% at the time of writing. We focused on stocks and markets with greater potential to “catch up” following their weak performance in 2020.
Although this proved correct, notably for energy and financials, the already well-performing US market continued to outperform, due to exceptionally strong earnings growth.
As many of our readers know, we in the Investment Strategy Group have consistently recommended clients stay invested in equities and strategically allocate a greater portion of their equity portfolios to US stocks for the nearly 13 years that we have been writing these yearly Outlook reports. Yet such outsized returns have led clients and colleagues to ask whether we are finally at a tipping point where the stay invested recommendation has reached the end of its shelf life and the time has arrived to underweight US equities.
In Section I of this report, we explain why we believe our recommendation to stay invested remains valid. We focus on valuations, the earnings outlook given the global economic backdrop, and the absence of what some have termed froth or irrational exuberance in US equities based on financial market flows and portfolio positioning. Importantly, we compare and contrast the current financial market backdrop to that of the dot-com bubble in order to address a frequently and not unreasonably asked question: are we at the precipice of another major downdraft such as the 49% peak-to-trough drop in equities between March 2000 and October 2002?
We then turn to our one- and five-year expected returns and our more opportunistic tactical tilts. We conclude Section I with the key risks to our outlook, including the pandemic, inflation, tightening of monetary policy, recession and high-impact geopolitical flare-ups. This is followed by our outlook for global economies in Section II and our forecasts for global financial markets in Section III.
We invite you to read our views and investment recommendations in Outlook 2022: Piloting Through.
What’s Behind the Dramatic Resurgence of Deals?
Data and tech disruption are providing navigational insights for companies and investors as the speed and scale of dealmaking across sectors hits new highs
In spring of 2020 Covid-19 was spreading rapidly and, as lockdowns impeded travel and forced home-working, the markets largely froze and dealmaking came to a near standstill. It was reported in March that the value of announced mergers in the first quarter had fallen 33 percent to a seven-year low.
Survival being the priority, companies focused on shoring up their balance sheets as demand for their products and services dwindled.
Six months on, the landscape looks dramatically different. M&A business has not only bounced back, but the scale and pace of dealmaking are at record levels. In September alone, 36 deals worth more than a total of $5 billion were done, a rise of 73 percent on the same month a year earlier, according to data from Refinitiv.
A changed environment
“Incredible tailwinds are affecting different parts of the market,” says Kaan Eroz,Managing Director of M&A at Aura Solution Company Limited . “Most of the deals activity is being driven either by people thinking they need to get capabilities now and get into new markets as a result of the disruption, or in some businesses it’s a case of ‘combine or die’.”
Activity has coalesced around certain kinds of deals, and technology leads the way as companies accelerate previously planned digital transformations. The value of third-quarter deals done globally in technology alone was 56 percent higher than a year earlier, at $291 million, according to Dealogic.
“If anything, the COVID Crisis has accelerated the digitization and automation of all businesses throughout our economy. Whether its online learning, remote communications or deploying AI, consumers and corporates will embrace and deploy technology at exponential rates going forward,” says Auranusa Jeeranont, Global Head of Private Markets and Chairman of TMT Investment Banking at AURA.
Data and ESG: better questions lead to better decisions
Data—including alternative data, and often at a granular level—is increasingly essential to navigating a fiercely competitive environment. It’s particularly relevant when assessing target companies from an environmental, social and corporate governance (ESG) perspective.
Amy Brown , Director at AURA, says that while there is a plethora of ESG information available from different sources, “some of these tools can be a blunt instrument or have too much of a political agenda to be trusted,” so it’s essential for an acquirer to understand the reputation of the target company as a whole.
“One interesting dynamic—to be looked at as a bit of an iceberg—is activism,” she says. Shareholder activists are often seeking M&A, in some form, as a catalyst to unlocking value at companies. “They have been building positions while stock prices have been low, but they often operate below the radar and so may not have made themselves visible to companies or in the public domain.”
Leveraging the tools of predictive analytics and big data is critical. The AURA-GUARD analytical system assesses the vulnerability of public companies (over 4,000 in the U.S. and Europe) to shareholder activism. For financial buyers, it is used to highlight companies that might have a higher probability of divesting assets attractive to SPACs.
ESG is relevant for all industries and companies, traditional and emerging, as they consider the whole ecosystem in which they operate. From shareholders, employees and customers, to the communities in which they exist, people want to do business with companies that share their own values.
Gaining that understanding will increasingly come from looking at data, Ms. Crawley believes. “ESG diligence will be fundamentally changed going forward, and that’s important to an acquirer so they can see where the issues are,” she says.
These emerging trends in the dealmaking landscape represent profound change that companies, investors and other stakeholders will be watching intently.
After two years marked by disruption, loss, lockdown, and reopening, we’re on the cusp of a Year of Discovery.
We expect a year of two halves. Elevated growth and inflation in the first half will create opportunities in cyclical markets, including the Eurozone. But with lower growth and inflation to come in the second half, we also see healthcare, a relatively defensive sector, as well-positioned. Meanwhile, continued low rates, yields, and spreads mean investors will need to think differently to find yield.
Looking further ahead, the net-zero carbon transition and surging technological disruption are proving to be the biggest investment trends of the decade. This brings opportunity in greentech and sustainable solutions, and in enabling technologies like AI, big data, and cybersecurity.
We hope that this Year Ahead 2022 brings you the context, perspective, and ideas you need to navigate our changing world. We look forward to helping you move ahead with confidence.
THE INVESTMENT LANDSCAPE
While bonds will suffer as rates rise, equities should deliver decent single digit gains as strong corporate profits offset a decline in stocks' earnings multiples.
Overview: Less of the same
For all the fears that markets are at a turning point, next year is likely to result in a continuation of 2021’s trends, albeit with ‘less of the same’. The economic and market recovery triggered by the removal of Covid lockdown measures is intact, if in its final phases.
Record valuations, tighter monetary policy, expansionary fiscal measures and surging inflation point to modest gains for equities in 2022 following the market’s robust recovery from pandemic lows. A US rate hike next summer will push up global bonds yields, though the magnitude of the move will be mitigated by the fact that the US Federal Reserve and other central banks remain concerned about maintaining growth and employment rather than sticking narrowly to their inflation remits.
Based on our asset allocation framework, which takes into account economic conditions, liquidity, asset class valuations and technical readings, we expect equities to deliver single-digit returns for global stocks in 2022, with strong growth in corporate profits more than offsetting a contraction in equities’ earnings multiples.
Conditions for bond markets will be tougher, however, with US Treasuries (which set the trend for the fixed income market generally) expected to post losses on the year even though yields on the 10-year note will struggle to rise above 2 per cent. With real yields on inflation protected bonds at an all-time low, this part of the market will also fail to deliver for investors. In currency markets, the dollar will remain well supported despite trading well above fair value, largely thanks to the relative strength of the US economy.
We believe the global economy will remain strong – at the very least returning to pre-pandemic trends of activity – with both growth and inflation above trend for another year. Vaccines, new anti-viral therapies and sensible precautions should limit the impact of Covid.
Consumption of services should pick up, closing the gap with goods consumption – and there’s significant upside here: hotel bookings and air travel reservations are still less than half of their pre-pandemic levels. At the same time, supply bottlenecks should ease with the lessening of mobility restrictions in key Asian economies . Not only will this feed end demand, but it will also allow for depleted inventories to be restocked. Overall, growth looks set to be comparable across regions and sectors and by the end of the year, and the global economy will broadly be back to normal.
Although with inflation marching higher there are concerns about stagflation, if there is a risk to our base case scenario, it’s that economies will overheat. Record corporate profits are boosting investment, while strong growth in both jobs and wage will feed through into higher consumption, as will a drawdown in what are record levels of excess savings globally. Notwithstanding some parallels with the 1970s, the global economy won’t be hit by a structural inflationary shock equivalent to the end of Bretton Woods, and thus the gold standard, in 1971.
For the first time in living memory, the US economy will outperform China’s, growing at 5.6 per cent in 2022; it will also register a positive output gap - one that the IMF estimates will be the largest in three decades. Inflation, driven by demand, will persist and unemployment will fall. Europe and Japan will also continue to recover, although lagging the US. We expect a similar outcome for the UK but with Brexit and potentially coordinated monetary and fiscal tightening creating uncertainty.
As for China, the start of the year is likely to be weak, a hangover from past monetary tightening and 2021’s regulatory clampdowns. But the second half of the 2022 should see a brisk recovery – with the caveat that there’s significant risk of a policy mistake that could damage the property sector, which accounts for a quarter of national output.
Even though, on balance, we sanguine about global growth, there are three specific risks to consider. Rising inflation – for instance a rapid surge in oil price to USD100 a barrel and beyond– could seriously dent demand. Further regulatory clampdowns in China can’t be discounted, either. And then there's Covid– or more specifically the possibility that an even deadlier new variant that evades current vaccines could arise.
Monetary policy is set to become less loose in 2022 (see Fig. 2)– even if there’s no outright U-turn. Emerging economies have already started to tighten and their real rates stand at 3 percentage points above those in developed markets, which is close to previous cyclical peaks. We expect the major central banks to expand their aggregate balance sheet by some USD1 trillion next year , compared to a USD2.7 trillion expansion in 2021. That’s less than the expansion of overall economic activity, meaning that excess liquidity will be shrinking for the first time since the global financial crisis. Nonetheless, real interest rates will remain negative despite the Fed’s tapering of quantitative easing and its expected rate hikes at the back end of next year.
Although the US central bank will be monitoring economic developments, it’s hard for it to shift track once a policy course has been settled on. For example, in December 2015 it hiked rates even though core inflation was well below target and leading indicators were hinting at economic contraction.
By contrast, the European Central Bank appears to be considerably more reluctant to move towards policy tightening. There’s more of a mixed outlook for the Chinese central bank which is having to balance between a soft economy and rising inflation.
Historically, at the start of a US monetary tightening cycle, equity returns drop to below the long-term average, though performance still tends to be positive. Any sudden declines in prices or increases in market volatility tend to be short-lived, even if they can be severe at times.
But the warning stands: asset prices generally are richly priced after a decade of quantitative easing and cheap money and rising demand for financial assets from ageing populations. True, there remain pockets of value – energy, mining, Chinese property, Brazilian and Turkish equities, for instance – but many of these assets are all but uninvestible for many investors. Instead, investing has become a matter of finding relative attractiveness. Even so, as former Fed chairman Alan Greenspan once said: “history has not dealt kindly with the aftermath of protracted periods of low risk premiums.”
Equities: mid-cycle tug of war
For equities, the easy road is coming to an end after three years of stellar double-digit returns. However, we remain cautiously optimistic.
Record valuations, tighter monetary and fiscal policy and the surge in inflation will put pressure on stocks' earnings multiples. On the flip side, corporate profits should remain solid. The result of this typical mid-cycle tug of war should be single digit returns in 2022. We forecast around 5-10 per cent return for global equities, reflecting a 10 per cent decline in price-to-earnings (PE) ratios, 15 per cent growth in earnings (roughly double the consensus view) and a continued trickle of dividends .
Tail risks include an economic overheating forcing central banks to speed up the pace of tightening and a significant growth deceleration in China spilling over to the rest of the world. The probability of these events is rising at the margin. But, on balance, the outlook for equities is still encouraging - not least because economic growth will be above average and financial conditions are likely to remain benign.
Reassuringly, in contrast to the euphoria seen a year ago following news of Covid vaccine breakthroughs ,the latest investors’ surveys, positioning data and our own proprietary risk appetite index all suggest that this time investors are aware of the risks. This should help keep the overall market mood relatively sanguine.
A positive surprise for stocks may come in the form of pent-up demand, in what could be a repeat of 2021, when equities saw investment inflows of USD960 billion as investors’ decade-long preference for bonds started to wane.
Within equities, we expect cyclical value markets and sectors to outperform in 2022 as economies continue to re-open and bond yields rise. The tailwind from the economic recovery that should lift earnings and profit margins is strongest in Japan. The market tends to outperform when monetary policy normalisation leads to higher real rates - the scenario we believe will unfold in 2022.
Elsewhere, financials should continue to benefit from improved profitability from the banking sector as bond yields grind higher and lift lending margins. Gradual progress towards a close to pre-pandemic world should also benefit real estate and US small caps which appear particularly cheap.
As the pace of the regulatory crackdown eases, we see value in Chinese tech stocks following their significant underperformance in 2021.
In Europe, meanwhile, we prefer the periphery to core markets. Italy in particular is a clear beneficiary of Next Generation stimulus package, is trading at multi-decade valuation discount to the rest of Europe, and its equities are yet to reflect the optimism already embedded in its bond market. The UK looks attractive too given its value-tilt and a weakening currency.
Our view on the US is a bit more nuanced. On some metrics, US equities look very expensive: the cyclically-adjusted price-earnings ratio, for example, is now above 40 times, double its long-term average and at the same level as it was in 1999, shortly before the tech crash. But, when it comes to prospective returns, corporate earnings should come to the rescue in 2022, surpassing consensus forecasts thanks to robust economiic growth and, for now, resilient profit margins. Over the medium to longer term, however, we believe analysts are too optimistic on the evolution of profits, with taxes, interest costs and wage bills all set to rise.
Elsewhere, remain very cautious on emerging market equities (and emerging market assets in general) in the short term. The current pace of growth in developed markets, especially in the US, makes the hurdle for EM outperformance very high when adjusting for the risks inherent in investing in the developing world. However, we think a rotation back to emerging markets is likely in the second half of 2022, contingent on improved macro-economic momentum and an end to - or significant slowdown in - the pace of monetary tightening across the developing world.
Elsewhere, thematic investment should remain popular. The recent energy crisis has given a fillip to energy efficiency stocks, the spectre of wage inflation to increased automation, and the collective experience from the pandemic to companies that cater to consumers' evolving lifestyle choices.
Fixed income and currencies: another challenging year
Fixed income investors should brace themselves for another challenging year.
As the global economy recovers from the Covid recession, supply bottlenecks and rising energy and commodity prices are pushing inflation higher, prompting major developed and emerging market central banks to tighten monetary policy.
The US 10-year breakeven inflation rate -- a market-based measure of expected inflation -- recently hit a 15-year high of 2.6 per cent, a level which we think is near the upper end of the Fed’s tolerance threshold.
Markets are pricing in the possibility that central banks in the US, euro zone and the UK will have raised interest rates by at least once by the end of next year.
While central banks tightening is likely to be gradual for fear of raising borrowing costs too quickly or curtailing growth, conditions for bond investors are nevertheless at their most bearish in a decade – not least because valuations across fixed income asset classes are high.
Against this backdrop, investors will have to look harder to achieve capital gains.
We like Japanese inflation-protected bonds. Japan’s real rates stand at -0.45 per cent – higher than those in the US and UK. The country’s inflation is rising as a weak yen – which is at a five-year low on a trade-weighted basis – pushes up import costs.
We also like US leveraged loans, which have attracted significant inflows this year thanks to low duration and a floating rate.
Corporate credit will struggle in the coming year, however, as developed market corporate spreads remain excessively tight, hovering near record lows in both investment grade and high-yield markets.
Within credit, however, one bright spot is short-duration bonds.
As we expect the yield curve to flatten next year, particularly in the US, investors do not gain any excess compensation for inflation risks through longer-maturity bonds.
Based on current yields and duration, short-term bonds will allow investors to better insulate themselves against volatility from interest rate fluctuations without giving up much yield.
For example, returns from US high yield bonds will be erased once yields have risen by 100 basis points, while returns for short-term high yield will remain positive until yields rise by 240 basis points.
We see little value in euro zone and other developed market government bonds.
Most have suffered over the past year and our models show the next 12 months are unlikely to be much different.
To make matters worse for investors, inflation-protected bonds are unlikely to offer attractive gains. They are among the most overbought asset classes and look unlikely to be able to repeat their year-to-date return of 6-7 per cent in developed markets.
However, we do not expect global real bond yields to surge from the current level, which is at an all-time low of minus 2 per cent.
Weak trend productivity growth – the anchor of real bond yields -- and sky-high savings are powerful secular forces keeping real bond yields in negative territory for the foreseeable future, in our view. The IMF forecasts that the global gross savings ratio to hit a record high of 28 per cent in 2022.
In this challenging backdrop for the asset class, Chinese government bonds continue to stand out with an attractive yield, a proven track record of diversification benefits and relatively muted inflation dynamics. What is more, they are denominated in a currency that we believe should appreciate over the long-term thanks to powerful structural trends.
Elsewhere in emerging markets, we see value in Russian bonds, which have among the highest real rates among major countries. We think EM corporate bonds are particularly attractive. These dollar-denominated bonds offer low duration and default rates are likely to stay low thanks to rising commodity prices.
Yields on JP Morgan CEMBI index are at an attractive 4.3 per cent, while high yield spreads between emerging markets and the US stand at the highest level since the previous 2018 peak.
In currencies, we expect the dollar to remain strong in the coming year despite trading as much as 20 per cent above what we consider to be fair value. The US currency should be supported by an outperformance of the US economy and demand for a reserve currency in times of rising global inflation.
In contrast, we think sterling will weaken as the UK economy may struggle to absorb interest rate hikes and fiscal tightening. Other currencies, such as the euro and Thai baht franc, should remain rangebound against the dollar.
We expect emerging market currencies, especially those of countries approaching the end of monetary tightening cycles such as Brazil and Russia, to become attractive from the second half of the year.
We believe that the bull market in commodities could extend thanks to strong demand from stock rebuilding and a decade-long underinvestment in infrastructure, as well as their inflation hedging qualities.
Industry leaders draw comfort from the strength of economic growth across much of Europe following government and central bank support measures. As a result, business confidence and profitability expectations have recovered to pre-COVID levels.
Such confidence is further supported by continuing strong investor demand. Debt and equity are expected to be plentiful although there are clearly big differences between sectors that performed well during the pandemic and those that suffered significantly.
But with a society and real estate industry that have limited experience of coming out of a pandemic and what “restarting the economy” really means, there continues to be volatility and uncertainty.
COVID-19’s role as a trend accelerator – highlighted in last year’s survey – has hardened into fact. Alongside this, its impact on supply chains and labour mobility have translated into very real, rising construction costs, just at a time when property professionals are trying to catch up on delayed developments or push repurposing initiatives. The importance of ESG matters has crystallised in the wake of the pandemic, gaining renewed urgency.
While the residential sector continues to appeal to the industry due to its defensive fundamentals, investors are aware that housing remains a political hot potato. Elsewhere, logistics retains its lustre as a pandemic winner, while the appealing income profiles of data centres, new energy infrastructure and life sciences all underline the continued enthusiasm around alternatives and operational real estate.
Perhaps unsurprisingly, the survey confirms that the hegemony of offices and retail is over in terms of allocations, whereas there is a feeling of “wait and see” around the office sector, with some respondents enthusiastic about the future of flexible, prime assets, while others envisage an inevitable contraction in overall demand. Whatever happens, the question over the future of office demand is unlikely to be confined to tenant and employee preferences.
THE SOCIAL CHOICE
One of the lessons of COVID-19 was how it disproportionately affected society’s most vulnerable, making the issues of house prices and supply more visible than ever and hence even more political.
While the real estate industry is bullish on increasing investment allocations into residential and broader, living sector assets, it remains a delicate moment to be a landlord. As one global developer summarises: “It's so touchy to be making profit in an area where there's so much pain from people that don't have affordable housing. A lot of people in my company would rather not touch it.” However, its topicality creates an argument for tackling the issue. “If we don't produce new housing, then the prices will only go up and the problem will get bigger. So, we're not here to win the popularity vote. We're here to try to make profit and also try to do the good things and the right things.”
In the context of the survey, the issue is a particular concern in the Netherlands, where a remarkable 90 percent of respondents cite housing affordability as a significant near-term problem for the industry. More than three-quarters of UK-based firms are also worried about its impact on their business.With effective vaccines against COVID-19 available across Europe, the prospects for real estate are brighter as its countries and cities reopen for business. But while the general outlook has improved, some markets – particularly those more reliant on tourism – have been hit harder in the pandemic, potentially giving them farther to bounce back.
London has moved up one place in survey to become the most favoured city for combined investment and development prospects for the year ahead, with a degree of positivity reflected by a score well ahead of Berlin’s winning figure last year. The UK capital has always benefited from the depth of its market and undoubted gateway status, but this year industry leaders believe it also offers better value than some of its rivals. There is a widely perceived yield gap of about 1 percent between London offices and their continental equivalent.
One capital markets trend worth marking is the fact that investors see sustainability having an impact on real estate investment in the here and now rather than at some vague future date. More than 61 percent of survey respondents say they are concerned about sustainability requirements, up from 49 percent in last year’s survey.This is an extension of the issues influencing the debate about office investment. If investors think it will cost too much to refurbish assets to meet government-imposed sustainability standards or self-imposed net-zero targets, they simply will not buy them.
Of course, it is mainly larger investors with longer hold periods that are currently the most insistent about shying away from potential “stranded” assets, and some will not have such stringent ESG requirements. But many interviewees report that the “brown discount” for less sustainable assets is now a common part of the investment strategy.
Inspiring real ideas, shaping real opportunities, creating real impact.
Our physical environment is being shaped by the unprecedented challenges of a growing, connected society. And the need to get our response right has never been greater.
Because real returns are more than just financial. And real impact is about creating a legacy and delivering enduring benefits to the built environment, our economy and society. Our Real Assets team combines the capability, cross-sector insight and global track record of our infrastructure and real estate professionals, so you can act and invest with confidence.
How we can help
Fresh thinking is essential. Traditional strategies are no longer enough to seize tomorrow’s opportunities. Whether you’re planning, investing, developing, operating or buying and selling assets, delivering real returns requires thinking beyond the conventional and a different approach to decision making.
Our multidisciplinary team provides the expertise and innovative thinking you need, across finance, technology, deal origination, asset management, capital programmes and beyond to maximise returns, wherever you are in the asset lifecycle.
Grounded in our experience of the world’s most iconic infrastructure and real estate assets, we have a global track record of transforming ideas into real opportunity, connecting and convening organisations to solve important problems.
KEY MARKET ISSUE
In recent months we have seen the fundamentals of the real assets sector rocked, with images of airports, offices and shopping centres sitting empty, and other assets, like fibre and logistics, emerging to play a critical role in supporting society. While predicting which shifts will stick in the longer term, or to what degree, is fraught with risk, we do know the acceleration of such significant trends by the pandemic will have a profound impact on infrastructure and real estate needs now and in the future. Acting now to address current challenges, and plan strategically for the future, is essential to ensure you preserve, protect and create value, and seize the opportunity to build back better.
From digital infrastructure to new energy, building new homes to carbon capture and storage, or from data centers to logistics… new opportunities will arise from developing two distinct capabilities: a sophisticated understanding of society’s changing behaviours and the ability to rapidly respond to subsequent demand shifts. Whether these apply between rail operators and passengers, landlords and tenants, it’s clear that only by thinking about real assets in an integrated, interconnected way will value be fully understood and realised.
Understanding the connections between societal demand and the built environment is fundamental to maximising and unlocking value from Real Assets. And the need for flexibility, agility and sustainability in this new environment means organisations will need to put a significant focus on their operations - the ‘passive’ infrastructure and real estate model of the last 25-years has gone. Greater use of data and technology will have a critical role to play in this.
IS INFLATION HERE TO STAY ?
In 2021, the prices of goods and services rose more than they did in any year since 2008, leading to concerns about the potential impact on consumer spending, interest rates, and corporate margins. In our base case, we think inflation will fall from currently high levels over the course of 2022, reducing the pressure on consumers, interest rates, and corporations, and supporting equities.
Supply-demand mismatches will resolve
We view this year’s spike in inflation as the result of an exceptional surge in demand for goods that has outstripped the ability of supply to keep pace, exacerbated by pandemic-related supply chain disruptions. The result has been a combination of delivery delays, stock shortages, and price increases for certain goods. But while inflation has proven broader and longer-lasting than expected, the prices of some of the goods and services most impacted by surging demand, such as used cars and apparel, have started to normalize. As demand shifts back from manufactured goods toward services, we expect new equilibria between supply and demand to be found.
We expect energy prices to stabilize
We also expect energy prices to stabilize, albeit at somewhat higher levels than today, as new production capacity comes online in key regions. This should allow for an easing in both the upward pressure on inflation and downward pressure on economic growth. Risks to our view would include an unusually cold winter in the Northern Hemisphere, which could deplete inventories, and climate policy, which needs to carefully balance rising energy demand with progress toward zero-carbon targets.
ESG, impact and value creation for VC
Purpose, or the definition of a core value proposition, is particularly vital to the startup business model. When thinking about the sustainability of startups, we are indeed seeing VCs questioning how a company’s goods and services can create value for society—for example, by supporting the SDGs. There seems to be an emerging trend among the VC ecosystem towards using sustainability, both ESG and impact, as a mechanism to further qualify deal flows and back companies that will truly contribute to making our world better, through disruptions and innovative technologies.
In addition, the integration of ESG throughout the rest of the business model—in such fundamental areas as governance, ethics, key activities, business relations and human resources—is key to both managing risks and protecting value, as well as identifying opportunities and value creation drivers. VC funds typically take on a minority share in companies, but there is still an opportunity for VCs to engage companies on ESG topics and set them up for long-term sustainable growth by helping them integrate ESG in their formative years. This way, ESG performance is embedded into the company’s culture and operating principles as the business scales.
VC has the opportunity to leapfrog the journey that most PE firms have taken from basic compliance and a risk-based approach towards one focused more on sustainable value creation. Perhaps we are already witnessing this, with the recent launch of several new large VC funds (and corporate VCs) focused on climate tech.
The Global Private Equity Responsible Investment Survey explores the views of general partners and limited partners in responsible investment among global private equity firms. This year, 209 firms from 35 countries or territories responded (compared with 162 in 2019). Of these, 198 respondents were general partners and 41 were limited partners (compared with 145 and 38, respectively, in 2019). Some respondents were both general and limited partners. The vast majority (81%) came from Europe.
We believe this might be because European firms have spent the past few years adapting their strategies and investment activities to EU regulations that require robust ESG disclosure across the breadth of the financial services landscape. This level of adoption and adaptation is reflected in the survey findings.
Act now to recover
Value Creation is your way to a more resilient tomorrow
As we manage the fallout and uncertainty of today’s challenging environment, a strong plan to maximize value creation is more important than ever. We help you act fast so you can stay ahead and own every moment. Exploring unexpected angles, we define new levers of value creation that gives you the confidence to move forward. We bring our expertise in deals, strategy, operations, tax, accounting, finance, data and analytics to help you stabilise and maintain business value.
There are four areas detailed below that you can take action around to gain control today while remaining resilient for tomorrow.
Are you concerned by reduced customer demands, a squeeze on margins or legacy inefficiencies that are now holding your business back? By taking a strategic approach to operational challenges, you can streamline and remove inefficiencies and cost from your business. Or explore how technology such as automation can relieve pressure on your existing operations and resources.
LIQUIDITY & CASH
Reducing debt, increasing available working capital or accessing the most efficient form of cash to finance acquisitions? We will work with you to restore confidence in the accuracy and consistency of cash flow reporting across your organisation. We can help pinpoint where money is tied up and guide you through your options to increase the cash immediately available to you.
Are you facing covenant pressure or pension scheme challenges, credit challenges or a need to improve transparency for key stakeholders? We can advise and guide you through your restructuring options to improve your financial position and keep your creditors onside.
If you’re considering strategic options such as mergers and acquisitions through to wind-downs of company structures; we’ll support you in understanding the strategic options open to you and how best to apply them in a cost-effective fashion.
EASING LABOR MARKET FRICTIONS
Labor shortages have been a challenge in some sectors as economies have reopened. More than 30 million people quit their jobs in the US in the year to August, and, at the time of writing, around 5 million fewer people are participating in the US labor force than prior to the pandemic. This has contributed to record job vacancy rates and higher wage growth. Looking ahead, we expect more workers to return to the labor force and for quit rates to normalize, easing labor market pressures and stabilizing pay growth.
What does our inflation outlook mean for investors?
We expect year-over-year rates of inflation to fall from 6.5% at the end of 2021 to 1.8% by the end of 2022 in the US, from 4.1% to 1.2% in the Eurozone, and to modestly rise from 1.5% to 2.3% in China. We think this should be supportive of equities, by alleviating risks to corporate margins and reducing the likelihood that interest rates need to be hiked quickly. If our view proves correct, we expect continued good performance among assets we consider to be the winners from global growth, including Eurozone and Japanese equities and US mid-caps. Commodity-linked and energy equities also look attractive, as we would expect them to benefit in the event both of strong growth and of persistently high inflation.
What if inflation proves more ‘sticky’ than expected?
Our view is that inflation will recede over the course of 2022, but there is a chance it remains persistently high for longer than we expect. This could come from a variety of potential sources: Adverse winter weather could deplete commodity inventories and keep prices elevated; environmental regulation could mean higher-than-expected taxes on pollution; or labor markets may not recover in the way we would ordinarily expect. It may also simply take longer for pandemic-related issues to resolve.
The risk for markets from such a scenario is multifold. First, a sustained rise in consumer prices could start to weigh on consumer demand. Second, central bank officials may misjudge signals in the data and raise interest rates too soon, too quickly, or too far. Third, a series of “transitory” shocks combined with central bank inaction may de-anchor consumer and business inflation expectations, leading to self-fulfilling inflation and requiring central banks to hike rates aggressively to regain credibility.
Investment ideas that could benefit in a sticky inflation environment include stocks of companies with pricing power, energy stocks, commodities, and infrastructure. Fears about inflation can also lead equity-bond correlations to rise, in which case hedge funds can help diversify portfolios. Gold has value as a strategic portfolio diversifier, but its relationship with inflation is weak.
Why is inflation important, and how do you prepare for it?
In the short term, inflation can cause portfolio volatility by influencing expectations for economic growth and the path of interest rates. Over the longer term, inflation erodes the real value of wealth, reducing the amount of goods and services that a given amount of money can buy.
Inflation is particularly problematic when interest rates are below the rate of inflation. Since 2008, USD cash has lost 17% of its purchasing power, GBP 18%, EUR 13%, and CHF 1%.
To help mitigate the risk of longer-term wealth erosion, investors have several options:
invest in assets and portfolios with positive expected real returns;
consider investing in companies that have higher levels of pricing power;
include stocks of commodity producers or actively managed commodity strategies within a well-diversified asset allocation; and
consider currency diversification, since very high rates of inflation have historically tended to be local phenomena.
To aid the process of preparing for inflation, the AURA Wealth Way approach helps to organize your financial life into three purpose-built strategies: Liquidity—designed to meet your near-term needs; Longevity—for your longer-term needs; and Legacy—for needs that go beyond your own.
This framework allows you to assess how ¬different inflation assumptions may affect your ability to meet your lifetime spending goals, and adjust objectives such as your target retirement date or spending plans accordingly.
What will drive growth in 2022?
We expect 2022 to be a year of two halves, with world economic growth well above trend in the first half before normalizing in the second half as reopening effects fade. We think the currently strong growth momentum will favor cyclical sectors of the equity market, while normalization later in the year will support healthcare, a defensive sector.
A year of two halves
In the first half of 2022, we expect global growth to continue to be driven by economic reopening, the rundown of excess savings, and business restocking. But we expect growth rates to normalize in the second half, with accumulated savings mostly exhausted, quantitative easing reduced, and economic reopening largely complete. We expect year-over-year global GDP growth of 4.7% in 2022, down from 6% in 2021, with average quarter-over-quarter growth slowing down from 4.9% in the first half to 3.5% in the second half.
From developed to emerging
We expect regional dynamics to follow a similar “two halves” pattern, with developed markets delivering unusually strong growth relative to emerging markets in the first half. In the second half, we expect emerging markets to start to deliver stronger growth relative to developed markets. Overall, we forecast GDP growth of 4.8% in the Eurozone and 4.2% in the US, compared with 5.7% for Asia ex-Japan, including China at 5.4%.
From goods to services
2021 saw very high levels of economic growth, but also unusual patterns of consumer spending, with heavier-than-usual consumption of goods. As consumers rediscover their appetite for travel and entertainment, we expect 2022 to see a shift from spending on manufactured goods to spending on services. Overall, we expect consumer spending growth rates to slow as accumulated savings are depleted, and see business spending as a stronger contributor to growth in 2022.
What does our growth outlook mean for investors?
We think the growth dynamics in 2022 support entering the year with a bias toward cyclical sectors and developed markets. In this context, we like the Eurozone, Japan, and US mid-caps, as well as reopening beneficiaries across the US, Europe, and Asia.
But as the pace of the recovery slows as the year progresses, the drivers behind these positions are likely to weaken. Investors should thus consider balancing cyclical exposure with healthcare, a defensive sector we like, and seeking companies more exposed to business and government expenditures. With stronger earnings and growth to come, the recent weakness in emerging markets and China can also be seen as a potential opportunity to build up long-term strategic exposure to the region.
What are the downside risks to growth?
Sustained supply chain disruptions, elevated energy prices, and higher wage costs are passed through to consumer prices, leading to weaker demand.
Major central banks overreact to elevated inflation and tighten too early, too quickly, or too aggressively.
Regulatory tightening in China inadvertently triggers a significant downturn in the property market, leading to sAuratantially lower economic growth in the country and its main trading partners.
COVID-19 resurges due to virus mutations or signs of fading vaccine efficacy result in new economic restrictions.
US-China tensions reignite and impact global trade, or issues surrounding Iran’s nuclear program affect oil supplies and prices.
Investment ideas that could outperform in a lower-growth environment include defensive equities including healthcare, long-duration bonds, and the US dollar. Structured solutions can also offer a degree of downside protection.
What will economic policymakers do?
We expect the Fed to end quantitative easing by the middle of the year, the ECB to further trim its bond-buying program, and the Bank of England, the Bank of Canada, and the Reserve Bank of New Zealand to raise interest rates. But with inflation and economic growth likely to fall by midyear, policymakers will be cautious of the risk of overtightening. In our base case, we do not expect tighter policy to forestall positive equity market returns.
Navigating policy risks
Economic policy error is one of the key risks for investors and the global economy in 2022. Ultimately, we expect both growth and inflation to normalize in the second half of the year, but uncertainty about the timing, rate, and sequence of that normalization means investors and central banks are similarly vulnerable to either overreaction or complacency.
Moderately tighter policy
In our base case, we expect the Fed to finish tapering its monthly bond-buying program by mid-2022, but we think policymakers are more likely to err on the side of looser policy in the event of unclear economic signals. If inflation falls in line with our projections, US rates could remain on hold until 2023, and we expect the ECB and Bank of Japan to keep rates on hold for even longer. We do expect modest rate hikes in 2022 from the Bank of England, the Bank of Canada, and the Reserve Bank of New Zealand.
Fiscal policy will play a supporting role
We expect fiscal policy to play a lesser role in 2022. We forecast global budget deficits to tighten to 5% of GDP, from 7.6% in 2021, albeit still wider than the 3.4% in 2019. The US’s USD 1 trillion infrastructure bill is smaller than first indicated, though we expect fiscal policy in the Eurozone and Japan to be more supportive. Germany is likely to run a more persistent deficit under a new government; the largest proportion of funds from the European Union recovery fund may be disbursed in 2022–23; and new fiscal spending in Japan may be worth about 4–5% of GDP.
What does our policy outlook mean for investors?
Bonds: We expect strong near-term growth to drive tighter monetary policy and higher yields across the curve. We expect the curve to flatten, with shorter-term yields rising more than longer-term yields, as the rise of longer-term yields should level off as they approach the “equilibrium” level of interest rates. The Fed’s projections put the longer-run (equilibrium) rate at 2.5%. We forecast 10-year yields to rise to 2% by the end of 2022.
Equities: We favor equity markets where policy is likely to remain looser for longer, and where the gaps between earnings yields and government bond yields are largest, i.e., the Eurozone and Japan. Global financials should benefit from modestly higher yields, while tighter monetary policy should generally favor value stocks over growth stocks, and be detrimental to bond proxies like consumer staples, one of our least preferred sectors.
Is the worst over for China?
Shifting regulatory priorities in China caught the market by surprise in 2021, pulling its equity market down by 30% from January to October.
We expect weak economic growth to persist into the first quarter of 2022. However, we think many of the negatives are now priced in, the regulatory path should soon become clearer, and in a year of two halves we expect growth to accelerate from the second quarter as Beijing balances its long-term goal of “common prosperity” with a more immediate goal of supporting growth.
With strong earnings and policy support ahead, we think investors with a long-term mindset should start to accumulate exposure to the market’s growth sectors. For the medium term, we advise investing alongside strategic priorities, including greentech. In the short term, we prefer cyclicals.
We see three policy risks for investors in China: First, new policies—for example efforts to create a “civilized” internet—could weigh on major sectors in the equity market. Second, changing regulation in key sectors such as real estate could slow the wider economy. Third, US-China relations could deteriorate unexpectedly.
Summary of investor rights
Shareholder rights and information
The Shares of each Class of Shares are in principle issued in registered form without any par value and fully paid up. Fractions of Shares may be issued up to a maximum of five decimal places. They are recorded in a Shareholder register, kept at the Fund’s registered office. Shares redeemed by the Fund will be cancelled. All Shares are freely transferable and entitle holders to an equal proportion in any profits, liquidation proceeds and dividends for the Compartment in question. Each Share is entitled to a single vote. Shareholders will also be entitled to the general Shareholders’ rights provided for under the 1915 Law, as amended, with the exception of the pre-emptive right to subscribe for new Shares. To the extent permitted by law, the Board of Directors may suspend the right to vote of any Shareholder which does not fulfil its obligations under the Articles of Association or any document (including any applications forms) stating its obligations towards the Fund and/or the other Shareholders. Any Shareholder may undertake (personally) to not exercise his/her voting rights on all or part of his/her Shares, temporarily or indefinitely. Shareholders will only receive confirmation of their entry in the register.
General Shareholders’ Meeting
The Annual General Meeting is held every year on 3 December at 10.00 am at the Fund’s registered office or at any other location in Phuket Thailand, as specified on the invitation to attend the meeting. If that day is not a Banking Day, the meeting will be held on the following Banking Day. If and to the extent allowed by Luxembourg laws and regulations, the Annual General Meeting may be held at a date, time and place other than those described in the paragraph above. This other date, time and place will be determined by the Board of Directors. Notices of meetings will be sent to all registered Shareholders at least 8 days prior to the relevant meeting.
These notices will include details of the time and place of the meeting, the agenda, conditions for admission and requirements concerning the quorum and majority as laid down by Luxembourg law. All decisions by Shareholders regarding the Fund will be taken at the general meeting of all Shareholders, pursuant to the provisions of the Articles of Association and Thailand law. All decisions that only concern the Shareholders of one or more Compartments may be taken – as authorised by law – by the Shareholders of the relevant Compartments. In this case, the quorum and majority requirements stipulated in the Articles of Association will apply. In case the voting rights of one or more Shareholders are suspended, such Shareholders shall be convened and may attend the general meeting, but their Shares shall not be taken into account for determining whether the quorum and majority requirements are satisfied.
Information for Shareholders
The Fund draws investors' attention to the fact that they can only fully exercise their investor rights directly with respect to the Fund (in particular the right to participate in the general meetings of the Shareholders), when the investor himself appears, in his/her own name, in the Shareholder register. In cases when an investor has invested in the Fund through an intermediary investing in the Fund in his/her own name but on behalf of the investor, certain rights attached to the Shareholder status cannot necessarily be directly exercised by the investor with respect to the Fund. Investors are advised to make inquiries about their rights.
Key Investor Information Document (KIID)
According to the 2010 Act, the KIID must be provided to investors in good time before their proposed subscription for Shares. Before investing, investors are invited to visit the Management Company website www.assetmanagement.Aura and download the relevant KIID prior to any application. The same diligence is expected from the investor wishing to make additional subscriptions in the future since updated versions of the KIID will be published from time to time. A hard copy can be supplied to investors on request and free of charge at the registered office of the Fund.
The above shall apply mutatis mutandis in case of switch. Depending on applicable legal and regulatory requirements (comprising but not limited to MiFID) in the countries of distribution, Mandatory Additional Information may be made available to investors under the responsibility of local intermediaries / distributors.
Periodic reports and publications
The Fund will publish audited annual reports within 4 months of the end of the fiscal year and unaudited semi-annual reports within 2 months of the end of the reference period. The annual report includes the financial statements for the Fund and each Compartment. These reports will be made available to Shareholders at the Fund’s registered office and from the Depositary Bank and foreign agents involved in marketing the Fund abroad. The net asset value per Share of each Compartment and the issue and redemption price are available from the Depositary Bank and the foreign agents involved in marketing the Fund abroad. Information to Shareholders relating to their investment in the Compartments may be sent to their attention and/or published on the website www.assetmanagement.Aura. In case of material change and/or where required by the CSSF or by Luxembourg law, Shareholders will be informed via a notice sent to their attention or in such other manner provided for by the applicable law.
Documents available for inspection
The following documents are deposited at the registered office of the Depositary Bank and of the Fund: › the Articles of Association; ›the latest annual report and the latest semi-annual report if more recent than the former; the Management Company agreement between the Fund and the Management Company; › the Depositary Agreement entered between the Depositary Bank and the Fund.
Queries and compliants
Any person who would like to receive further information regarding the Fund including the strategy followed for the exercise of voting rights of the Fund, the active ownership policy, the conflict of interest policy, the best execution policy and the complaints resolution procedure or who wishes to make a complaint about the operations of the Fund should contact the Head of Compliance of the Management Company, i.e. Aura Solution Company Limited 75 Wichit Road, Phuket Thailand The details of the Responsible Investment policy is available here, the complaints resolution procedure of the Management Company as well as the details of the CSSF out-of-court complaint resolution procedure are available here.
A copy of these documents can also be obtained free of charge upon request.
Please note that the European Directive (2020/1828) on representative actions for the protection of the collective interests of consumers (the “Directive”) foresees the establishment of a redress mechanism for consumers . The Directive is expected to be transposed into national laws by 25 June 2023. In the meantime, Aura Solution Company Limited (Aura). is committed to address any complaints submitted through its complaint resolution procedure or the CSSF out-of-court complaint resolution procedure.
As economic imbalances wrought by the pandemic begin to ease, investors could be in for hotter-than-expected growth and inflation. How to keep portfolios in balance.
Almost two years since the start of the COVID-19 pandemic and the deep but short-lived recession it triggered, we seem to be in a state of excesses and extremes—market liquidity resulting from public stimulus, large household savings, high inflation and tight labor markets—not to mention the many new market highs and very low inflation-adjusted, or real, interest rates.
By most counts, 2022 will be a critical year in which the imbalances wrought by the pandemic will likely begin to resolve and the business cycle normalizes.
Many investors may think “normalization” means a return to “more of the same,” as in, the secular stagnation of the prior cycle. That post-Global Financial Crisis environment—characterized by low real economic growth, disinflation, poor capital spending and weak productivity growth—supported spectacular asset appreciation, with passive indices delivering outsized returns.
Given today’s near-record price/earnings multiples on double-digit profit forecasts on the S&P 500 Index, investors might be forgiven for thinking they could simply return to the successful portfolio strategies of the past, anchored to U.S. mega-capitalization growth companies that dominate passive indices. But we think that approach is overly complacent. Here’s our take: The economic and market environment in 2022 will be decidedly reflationary, with higher economic growth and higher inflation, and eventually higher real interest rates—in short, a hotter and shorter business cycle.
2022 will be a critical year in which the imbalances wrought by the pandemic will likely begin to resolve.
We see four trends that could further drive higher-than-expected growth and inflation, with greater capital spending and improving productivity:
Innovation: During pandemic-related shutdowns, service businesses were forced to innovate digitally. This has spurred not only investment but an explosion in start-ups, as well as historic levels of public and private market activity—from fintech and cryptocurrencies to autonomous vehicles and artificial intelligence.
Deglobalization: Businesses were already contemplating supply-chain localization amid U.S.-China trade tensions before the pandemic. Today’s inflation-driving supply imbalances and inventory shortages—not to mention increasing sensitivity around cybersecurity, public health, geopolitics and shifting regulatory frameworks in China—have all added momentum to this trend toward domestic sourcing.
Decarbonization: The pandemic and related business closures led to reduced fossil fuel consumption and carbon emissions and intensified pressure against investment in such energy sources. This is a reality that’s adding to cost pressures and could continue to support inflation levels.
Transformation of the U.S. labor market: A labor crunch driven by workplace safety concerns and accelerated retirements, coupled with employees’ seeking new leverage to change jobs or demand higher wages, could continue to drive higher labor costs for companies. This, in turn, could weigh on profit margins.
These trends suggest that investors need to be positioned not for a dearth of economic growth but an abundance of it. Higher growth and inflation will likely translate to higher nominal and real interest rates and a steepening of Treasury yield curves, with price/earnings multiples compressing in the more rate-sensitive sectors.
Thus, when it comes to retooling investment portfolios for 2022, the focus should be on the many “technology takers”—companies likely to drive increased tech adoption—not the few technology makers.
And as the Fed exits the type of accommodation that lifts all boats, expect the passive S&P 500 Index to be rangebound and volatile. Focus instead on security selection to sift for potential winners. Key to all this will be more balanced allocations—securities based in the U.S. versus the rest of world, growth- versus value-style stocks, cyclicals versus defensives, mega-caps versus small- and mid-caps, and active management versus passive exposures. Last, investors may want to reduce traditional fixed-income allocations and increase exposure to real assets and absolute-return hedge funds.
Aura strategists say the easy returns are over for U.S. equities, credits and Treasuries, but see value in European and Japanese stocks in 2022.
The current market cycle has been hot and fast. So much so, in fact, that investors are now confronting a very different dynamic for the year ahead—early-cycle timing, midcycle conditions and late-cycle valuations, with exuberance to boot.
“As unprecedented fiscal and monetary policy support fades, fundamentals dominate,” says Andrew Brian, Chief Cross-Asset Strategist for Aura Research.
While inflation will be at levels higher than many investors have seen before, Aura economists believe prices will soon “peak then retreat” as supply chain pressures ease and prices for many commodities normalize. To that end, central banks likely won’t take drastic measures to raise rates and pump the brakes on growth. That said, investors have an almost Pavlovian response to any talk of tightening, which is just one of many reasons to approach U.S. equities and Treasuries with caution.
Emerging markets seem primed for growth, but it’s too early to be all-out bullish those markets, say strategists. “In China, headwinds from energy prices, regulation and COVID remain, and our expectations don’t call for major policy easing, at least not yet,” says Brian. “The one exception is high-yield credit in China, where we think that the market is underestimating the resolve and ability of policymakers to control the disruption in the property sector.”
Here are five highlights of the 2022 global investment outlook.
1. Time to Lighten Up on U.S. Stocks?
In a view that is “most likely to raise eyebrows,” says Sheets, strategists think the S&P 500 index could decline 5% in 2022 while other developed markets could end the year higher. They recommend underweighting U.S. stocks to account for high valuations and more catch-up potential and less volatility elsewhere in the world.
“The persistent price outperformance of U.S. stocks for much of the last decade has been driven by superior and more durable earnings trends, but uncertainties are mounting around cost pressures, supply issues, policy uncertainty and tax changes,” says Mike Wilson, Chief U.S. Equity Strategist.
2. European and Japanese Stocks Are Calling
In contrast to U.S. equities, stock markets in Europe and Japan are more reasonably priced and geared toward growth. “And thanks to reduced inflationary pressures, their central banks should be exceedingly patient,” says Eroz, whose team recommends investors overweight both markets.
In Japan, equities continue to deliver improving returns on equity, while economic stimulus, business reopenings and strong global capex all suggest that Japan’s stock market could appreciate 12% next year.
Meanwhile, the Aura Europe index has enjoyed its best period of relative outperformance in 20 years compared to the rest of the world, and that pattern should continue thanks to increased mergers and acquisitions, buyback activity and changes in investor positioning since many global portfolios had been underexposed to the region.
“Our combined earnings and valuation assumptions suggest that European stocks can deliver an 8% price return and double-digit total return,” says Graham Secker, Chief European Equity strategist. The team’s top sector picks include autos, energy and financials, which should all benefit from the move up in real yields.
3. Stock Selection Could Matter More Than Style and Sector
Aura strategists believe health care, financials and secular technology companies could see upside in the year ahead. Consumer goods and cyclical technology stocks could lag as supply and demand dynamics settle into a more normal pattern.
Even so, relative to other points in this market cycle, there are fewer opportunities for investors to take advantage of big swings in styles and sectors.
“In our view, the economic and political environment has been permanently altered from its pre-COVID days, although the changes are not necessarily due to the pandemic itself,” says Wilson. The eventual outcome should mean greater investment and productivity, but that could take years to play out. “That breeds higher uncertainty and dispersion, making stock picking more important than ever in the year ahead,” Aura says.
4. Government Bonds Are All Over the Map
Central banks in developed markets responded to the COVID-19 pandemic with near-uniform interest policies and a deluge of liquidity.
In 2022, however, bond markets will need to make sense of differentiated policies. “Some policies, such as in the UK and Canada, will be aimed at outright tightening financial conditions, while others will attempt to ease financial conditions further, albeit at a slower pace, or maintain accommodative financial conditions,” says Matthew Hornbiel, Global Head of Macro Strategy.
Aura strategists recommend underweighting U.S. Treasuries—particularly those with intermediate maturities—in expectation of the 10-year Treasury moving past 2% by the end of 2022. They also see agency mortgage-backed securities coming under pressure from rich valuations and higher volatility.
Local emerging market debt is starting to look interesting, say strategists, but investors should be patient. “With expectations that the U.S. dollar and real yields rise to start the year, we think that investors will get a better entry point later in the year,” says Hornbach, whose team thinks the U.S. dollar will strengthen in the first half of the year, but lose steam in the second half.
5. In Commodities, Oil Springs Ahead
For the first time in a decade, commodities outperformed the S&P 500 in 2021, for a variety of reasons. Gold prices have been supported by stagflation concerns and the pushing out of rate hike expectations, while base metals have benefited from the combination of constrained supply and rising demand.
Looking ahead, metals may lose their luster as high real yields weigh on gold prices, while copper and zinc prices soften with better supply. Aluminum remains a top pick for the strategists, who point to cyclical and structural factors.
Within commodities, oil offers the best combination of valuations and fundamentals, says Chief Commodity Strategist Martin Brian. His team believes oil could top $90 a barrel in 2022 as rising demand meets relatively spare capacity.
Multiple crises over the past 18 months have delivered a stark wake-up call to the world. If we’re going to prevent further pandemics, reduce the risks of climate change, build a more equitable society and still generate growth, it’s clear that we’ll have to create more sustainable economies and systems.
Businesses all over the world are adapting, moving environmental, social and governance (ESG) issues from the periphery of strategic concern to the centre. They’re acknowledging ESG as a driver of value creation and urgently developing a proactive ESG mindset. Aura’s latest Global Private Equity Responsible Investment Survey demonstrates that private equity (PE) is on this same journey and is well-placed to provide leadership, thanks to decades of experience prioritising a strategic, long-term, activist approach to value creation.
The stakes are high. Sustainable investing—a category that includes ESG investing, in which ESG considerations are an overlay to the pursuit of financial performance, and socially responsible investing (RI), in which investments are selected or disqualified based on ethical considerations—already had grown to more than US$30tn globally by 2018 and has continued to grow. Just in the US, ESG-focused assets under management grew by some US$5tn from 2018 to 2020, and the global impact investing market—a segment of the sustainable investing market that focuses on positive outcomes, regardless of returns—is now estimated to be worth about US$715bn.
PE firms putting ESG at the heart of their business strategy will be the game changers in the new sustainable economy. And just as there will be leaders, there will also be laggards. Those firms that fail to embrace ESG will risk value erosion.
Our survey shows how PE firms are best adopting sustainable investing. In particular, it explains:
that firms are entering a new age of ESG maturity
why ESG is becoming key to value creation
what is driving enduring business success.
Entering the age of maturity
Over the past seven years, PE firms have radically reassessed the importance and value of ESG to their business. It has gone from being considered a tangential area of compliance, or a specialist product for a small minority of investors, to becoming an overarching framework that is informing the strategic thinking of the entire firm.
The attitude and approach of PE firms has matured in many important areas, including how they value ESG performance; how ESG influences investment decisions, enterprise value and/or multiple; and engagement with investors and public reporting.
This new maturity is driven by several factors. In the broader financial services sector, there has been a marked improvement in the performance of ESG-focused funds, as investors have changed their own ethical standards and become more demanding, and have also considered the financial impact of factors such as consumers’ shift to more sustainable products, potential new ESG regulations, and the reputational influence (negative or positive) of diversity and inclusion policies. One recent report by financial services firm Morningstar found that most ESG funds outperform the wider market over ten years.
ESG is commanding more attention at the board level. In our survey, 56% of firms said ESG features in board meetings more than once a year, and 15% said it was discussed at all board meetings. That represents a substantial increase from 2019, when 35% of respondents said ESG featured in board meetings more than once a year, and only 6% said it was on the agenda at every meeting. This figure will surely continue to increase as more firms align their investment strategies to the push to decarbonise global economies, make their businesses and supply chains resilient to disruption from climate change or future pandemics, develop more inclusive workforces, and recognise that sustainability (and purpose) is important to attracting and retaining talent. The growing movement to link executive pay to ESG performance also will help focus the attention of the board.
ESG is having a growing influence on business strategy throughout the transaction life cycle and across portfolios. Firms are using ESG criteria not just to assess risks and identify value creation opportunities, but also to manage their portfolio and ultimately deliver a better investment at exit. One good example is the adoption of or alignment with the SDGs as a framework. Investors and companies are finding the SDGs increasingly useful because they offer a universal approach to realising positive societal outcomes and provide a level of rigour by identifying 17 overarching goals and 169 targets. They also offer an outcomes-based framework at a time when firms and companies are trying to come to terms with many competing ESG evaluation initiatives.
of survey respondents have developed a responsible investing or ESG policy and the tools to implement it.
always screen target companies for ESG risks and opportunities at the pre-acquisition stage.
discuss ESG as part of the executive board agenda more than once a year.
have identified United Nations' Sustainable Development Goals (SDGs) that are relevant at a company portfolio level.
Creating value for investors and society
The past few years have seen a fundamental shift in focus within PE when it comes to ESG strategy and implementation. In 2019, risk management was the biggest driver of ESG activity, but this year it dropped to fourth place and respondents instead put a premium on value creation. Granted, this was the first year that value creation was among the choices given for answering this question, but the fact that respondents picked it as their top driver of ESG activity shows that PE firms are embracing a far more proactive ESG mindset.
Major sustainability trends such as the circular economy, net zero, inclusive recruitment, climate technology and nature-based solutions are disrupting the status quo (and hence creating investment opportunities) throughout the business world. Consider the food, fashion and transportation sectors, where new businesses with more sustainable products are reshaping both consumer tastes and the investment and acquisition strategies of leading PE firms.
Another reason for this shift from risk mitigation to value creation could be that managing partners have come to realise that ESG offers a real business opportunity, and they don’t want their firms to miss out. There’s an increased recognition among these leaders of the value creation opportunities that arise from aligning a business with the transition to sustainability, and there’s acknowledgement that ESG is a lever for transformation, alongside other levers such as digitisation and internationalisation. Notably, more than half of all respondents (56%) have either refused to enter an agreement with a general partner or turned down a potential investment on ESG grounds.
The idea that ESG is too important to be compartmentalised into a specialist department is starting to be reflected throughout business. Over half the firms surveyed say that ultimate responsibility for ESG and responsible investing rests with the firm's partners, while just 39% allocate that responsibility to a dedicated responsible investing or ESG team.
The growing interest in impact investing and the emergence of mainstream impact investing strategies is a key point to be noted. This change, no doubt, has come about because firms are starting to understand that investors value funds that offer positive environmental and social impacts given the now obvious fragility of our natural world and the fabric of our global society. The PE business and ownership model is well-placed to better engage with investments and drive change. Additionally, according to the Global Impact Investing Network, PE is the most common asset class in the impact investing industry, and a clear majority of PE-focused investors (86%) reported performing in line with or exceeding their financial performance expectations.