We see opportunities to deploy capital in some niche areas of the investment landscape and reshape (or at least re-evaluate) some areas of the portfolio. Simultaneously, we are closely monitoring the lurch toward protectionist trade policies and their impact on global economic activity. We detail these risks and opportunities fully in Outlook 2020: Ten Investing Themes for the Coming Year. Let’s start with the gloom and finish with the optimism.
The biggest risk to portfolios in 2020 is that weak global growth could deteriorate further. In particular, we worry that the incessant jousting over trade could undercut activity and that central banks have little “juice” left to counter weakness.
Economic growth is sluggish, and consensus forecasts peg 2020 growth to slow further in the United States, Europe, Japan, and China. While employment is generally robust, nearly three years of trade battles have left consumers and businesses on edge. The average US tariff on Chinese exports now exceeds 21% after doubling over the past year; this increase boosts costs for consumers and businesses and forces businesses to rethink supply chains to deal with impacts that could persist or could evaporate in a few quarters or years. As Outlook 2020 points out, trade uncertainty is unlikely to fully lift next year, and the Trump administration’s avenues to boost growth in the run-up to the US presidential election are limited. The gloom is not limited to the United States. Germany, Japan, and other developed economies are struggling, and China and India are well off their recent pace as well.
Could the global growth slowdown be on the cusp of a reversal? Maybe, but even if so, a true breakout seems unlikely. As we explain in Outlook 2020, labor markets are tight, so GDP is increasingly dependent on productivity growth. Globally, that growth has averaged less than 1% over this entire business cycle, after growing at more than twice that rate for several decades.
Bond markets are already pricing in an anemic environment (though would probably rally further in an outright recession); some risk assets, however, are not. A global recession certainly isn’t our base case, but it’s the key risk to portfolios today.
Enough about the risk: How about the opportunity? As stated at the outset, we see some attractive niche destinations for capital, many of which are in either semi-liquid or private markets. In credit, CLO debt markets are under some pressure, but fat yield spreads and excess collateralization provide some protection. Investors that navigate this complex and not-always-liquid marketplace will likely do better than those in corporate bonds.
Though valuations for large-cap buyouts and late-stage venture capital investments are rich, nimble investors can find pockets of value by buying existing interests at a discount from other limited partners. The secondary market has grown nine-fold over the past decade. Price discounts only average about 10%, but secondary funds and well-advertised auctions aren’t the only game in town. For investors with speed and appropriate expertise (or outside resource), direct deals can offer fee savings and opportunities to cherry pick deals and recontour their private investment portfolios.
One area of portfolio reshaping that investors should consider is the allocation to fundamental equity long/short managers. The alpha potential from generalist equity long/short managers is structurally impaired due to factors including the growing clout of quant, passive, and multi-manager funds, as well as corporate disclosure requirements. In the coming year, investors should consider replacing this exposure with specialized long/short strategies or with lower-cost alternatives like options writing.
Investors can also use 2020 to re-evaluate their portfolio’s resilience to systemic risks such as climate change. The frequency of billion-dollar weather disasters is 79% higher this decade than from 1980 to 2018 (inflation-adjusted). New analytical tools enable sophisticated analysis of portfolios’ exposure to climate change, and on the flip side, investors can build exposure to climate mitigation and renewable energy strategies.
Positioning the portfolio to benefit from a global recession is ill advised. An investor that shifted exclusively into safe-haven assets in early 2019 would be considerably poorer today. Rather, investors should ensure their portfolios are resilient to both near-term threats and long-term disruption, and economic uncertainty doesn’t dissuade them from spotting attractive opportunities.
Sean McLaughlin, Head of Cambridge Associates’ Capital Markets Research