Ten Years on from the Global Economic Conflagration, What’s on Tap Now for Institutional Investors?

Cambridge Associates Report Highlights New Challenges, Risks and Realities as Global Financial Crisis Recedes from Investors’ Minds

BOSTON (September 17, 2018) – After the value of global equities shrunk by nearly $20 trillion between 2007 and early 2009, the world’s charred markets, spurred on in part by central banks’ and regulators’ stimulative actions, spread their wings. And, over the next decade, the market value of equities tripled, surpassing pre-Global Financial Crisis levels.

But everything cycles, so pondering what’s next can be productive. In “Rising from the Ashes: Key Developments Since the Global Financial Crisis,” strategists at global investment firm Cambridge Associates put forth a potential set of new realities.

• Tightening Ahead. Next year may be when major central banks stop expanding their balance sheets in aggregate for the first time in a decade – replacing quantitative easing with quantitative tightening. Their motivation may be saving fire-power to fight the next recession. But in the process, they could actually speed its arrival, along with inflation. “Tightening of global liquidity will be a headwind for asset markets, especially credit and the emerging market asset classes,” says Aaron Costello, report coauthor and Managing Director at Cambridge Associates.
• Unabated headwinds for banks. Since the pre-crisis days, profitability for banks has dropped because of new regulations, lower interest rates and the decline of previous cash cows like investment banking and proprietary trading. For traditional investment banks, new competitors from boutiques in areas like mergers advice, and from so-called shadow banks in leveraged lending and asset-based finance, will continue to stymie growth and profits. And then there’s the impact of disruption from technology.

“While tools like artificial intelligence and big data can improve loan screening and enhance the ability to market new products, the flipside is that technology also creates new competitors for banks in areas like online payments and marketplace lending, increasing options for customers while pushing bank margins lower,” says report coauthor Wade O’Brien, Managing Director at Cambridge Associates. He points out that Alibaba in China and Rakuten Ichiba in Japan have already displaced banks, in areas such as asset management and credit cards.

• Technology: You probably haven’t seen this movie before. Investors are paying rich multiples for companies developing technologies like autonomous vehicles and artificial intelligence. At the same time, investors who watched tech stocks dominate in the late 1990s and then plummet by 80% may wonder if things are heading in the same direction. But today’s era of tech dominance may proceed differently. “A big difference is that today’s technology firms generate oversize profits. In fact, you can make the case that valuations have remained reasonable even amid stunning returns, as the rapid rise in share prices has simply kept pace with a corresponding rise in profits,” says report coauthor Sean McLaughlin, Head of Capital Markets Research at Cambridge Associates. He points out that tech returns have been strong not just among publicly traded firms, but also among those within private investments.
• Political risks are rising – and there are many ways to be stung. Populist rhetoric about trade, immigration and growing income inequality have fueled anti-globalization sentiment, and politicians leveraging these concerns have had a pronounced impact on domestic and foreign policies. “With elevated valuations and data suggesting the US is likely in the late-cycle phase of economic expansion, global markets may be more vulnerable now to poorly conceived policy than at any time in recent years. Any considerable retreat in cross-border trade, capital flows and even migration may feed inflationary pressures and force asset prices lower,” says report coauthor Kevin Rosenbaum, Deputy Head of Capital Markets Research at Cambridge Associates.
• The cooling of investors’ romance with passive investing? During the bull market, the difficulty that active investment managers have had keeping up with indices intensified, and investors have continued to migrate away from fundamental, actively managed strategies and into index funds, ETFs and “smart beta” strategies. But the net flows out of active strategies seem to be slowing, and that could be a sign of what’s to come. “Market volatility and a dispersion in the price of assets could rise, as central banks pull back on easing the flow of money. Plus, current US equity valuations suggest the potential for more moderate market returns over the next decade. Both of these scenarios could provide a more conducive environment for highly skilled active managers going forward,” says coauthor Michael Salerno, Senior Investment Director at Cambridge Associates.

How should investors respond to these dynamics, scenarios and potential new realities? Celia Dallas, Cambridge Associates’ Chief Investment Strategist and a report coauthor, says investors will be best served by seeking even greater diversification of return sources; recognizing that defending a portfolio’s value in the next recession may look different than doing so in the last one, and carefully evaluating active managers to understand how stable they will be in an age of disruption.

“In an era of geopolitical risks, diversification and careful liquidity management are the best lines of defense,” Dallas says. She points out that in this environment long-dated sovereign bonds will probably remain one of the best portfolio diversifiers – and that cash and short-maturity sovereign bonds can also offer important advantages should inflation expectations increase.

About Cambridge Associates

Cambridge Associates is a leading global investment firm. We aim to help endowments & foundations, pension plans, and private clients implement and manage custom investment portfolios that generate outperformance so they can maximize their impact on the world. Working alongside its early clients, among them leading university endowments, the firm pioneered the strategy of high-equity orientation and broad diversification, which since the 1980s has been a primary driver of performance for institutional investors. Cambridge Associates delivers a range of services, including outsourced CIO, non-discretionary portfolio management, and investment advisory services.

Cambridge Associates maintains offices in Boston; Arlington, VA; Beijing; Dallas; London; Menlo Park, CA; New York; San Francisco; Singapore; Sydney; and Toronto. Cambridge Associates consists of five global investment consulting affiliates that are all under common ownership and control. For more information, please visit www.cambridgeassociates.com.