Investment opportunities 2022
Natixis Investment Managers, Global Survey of Institutional Investors conducted by CoreData Research in October and November 2021. Survey included 500 institutional investors in 29 countries throughout North America, Latin America, the United Kingdom, Continental Europe, Asia and the Middle East.
One key reason for a majority of institutional investors finding themselves in good standing at the end of 2021 is the swift action taken by policy makers to respond to the pandemic in 2020. Looking at the potential for the unprecedented public health crisis to escalate into a global financial crisis, central banks leveraged two critical policy tools: lower interest rates and quantitative easing.
In the short term, not only did the coordinated monetary and fiscal measures help to avert a crisis, they also fueled rapid economic growth. And along with growth came the first inflation in more than a decade. Almost two years in, institutional investors recognize the challenges these policy decisions present, and they rank inflation (69%), interest rates (64%) and valuations (45%) as their top portfolio risks.
Inflation mostly seen as transitory
While inflation is the top portfolio concern, six out of ten institutions believe it is transitory. They are more likely to say inflation is structural (55%), thanks to a combination of loose monetary policy and low interest rates, rather than cyclical (45%). Some may see inflation as a downside to relaxed monetary policy, but nobody is eager to see a change in course. In fact, 68% predict the bull market will end when central banks stop printing money.
Not all believe inflation is a short-term phenomenon. More than one-third (37%) worry that massive stimulus efforts could result in unchecked inflation. Over the long term, more worry that stimulus will result in tax hikes (58%) and increased risk of a future crisis (49%). While stagflation (31%) and future cuts to social safety nets (23%) are additional concerns, one-third of institutions also find that inflation presents an upside of expanded investment opportunity.
Interest rates challenge investment strategy
Inflation poses a number of long-range economic issues, but interest rate policy presents institutional teams with more immediate investment challenges. Low rates are nothing new. Institutions have been living with them for more than a decade. During the pandemic, however, rates went even lower, and in many cases sank into negative territory.
As a result, about one-third of those surveyed have had to bite the bullet an invest in securities with negative yields, including 37% of insurers who need bonds to meet future cash flow needs and risk requirements. But with time the trend may be moderating as only one-quarter of those surveyed anticipate substantial increases in the volume of negative yield securities, which is down dramatically from 53% in our 2021 outlook survey.
Beyond investing in negative yield securities, institutions have had to look further afield for bond replacements, including the 68% who report they’ve turned to alternatives. As a result of the hunt, 69% of those surveyed caution that institutions have taken on too much risk in pursuit of yield.
Given the likelihood of rate hikes in 2022 and 2023, seven in ten say their institution is looking to short-term bonds and ETFs to counter duration risk in their fixed income portfolio.
High valuations and high expectations
The effects of low rates – along with high levels of liquidity – are felt well beyond the bond market. In fact, eight out of ten institutions say low rates have distorted valuations. Another seven in ten (71%) say current valuations do not reflect the fundamentals, and the same number believe the current pace of growth is unsustainable. The effect has been so strong that one-fifth of those surveyed go so far as to throw up their arms and say valuations no longer matter.
A freewheeling environment coupled with easier access to trading tools has led retail investors to pile into stocks. As a result, eight out of ten (78%) are worried that retail investors have been more careless in speculating on high risk assets. That concern may be well founded as individual investors now say they expect investment returns of 14.5% above inflation over the long term, 2 a figure 174% greater than the 5.3% financial professionals say is realistic. 3
As an example of the risk concerns, six out of ten institutions (62%) believe the meme stock phenomena will create financial bubbles. And overall, 64% worry that easier access to trading is ultimately a threat to the retirement and financial security of individual investors.
Crypto tops correction concerns
Given all the factors at play, institutions see the potential for corrections in a range of asset classes and sectors. Hugely popular cryptocurrency tops the list with more than half of institutions calling for a correction. This is followed by interest-rate-sensitive bonds (45%), stocks (41%) and technology (39%).
It is among the most well-liked investment choices among Indians. But, although real estate investment opportunities have produced incredible profits, such options have their own risks and restrictions. The real estate segment carries several risks, one of which is the lack of liquidity. If you need to sell the house soon, you could have to offer a steep discount. This might also lead to a loss of capital. Furthermore, you will need to sell the entire property even if the amount of money you need is less than the asset’s value. Again, the volatile nature of prices is another risk factor that investors should take into consideration. Other limitations include the size of investments which is quite large when it comes to real estate. If you don’t have a sizable amount, you won’t be able to access this investment segment.
The government has developed several small savings programs for those seeking to engage in extremely safe investment options. These programs provide investors with guaranteed returns with zero volatility. Yet, your returns are smaller than those of market-linked investments like NPS, mutual funds, and equities. PPF currently yields a 7.1% return which is revised on a quarterly basis. Whereas, other government schemes offer average 4.5% – 7.60% p.a. Besides, these options are usually for investors who cannot afford to lose their money.
Small savings plans often outperform FDs and inflation . Investment choices, including Public Provident Fund (PPF), Senior Citizens Savings Scheme (SCSS), the Sukanya Samriddhi Scheme, and the Kisan Vikas Patra, etc. which are small savings plans for the long term.
Investing in equities is among the finest and also the riskiest strategies to build wealth for your long-term objectives. There are many instances of equities that, over time, have increased investors’ wealth.
An investment of Rs. 10,000 in Bajaj Finance in January 2007 would have grown to more than Rs. 18 lakh in January 2022 to put this return in context. Your assets would have increased 180 times, in other words.
Like Bajaj Finance, other stocks have become investors’ wealth sources. But, a lot of businesses have also proven to be wealth destroyers. Consider Reliance Communications as an illustration. From their high in January 2008, its stock prices fell by 98–99%. Additionally, owners of these stocks saw their value diminish.
Direct investment is possible in company stocks. Finding the correct supplies, yet, is the actual difficulty. Additionally, choosing the proper stocks is tricky, given that there are more than 5,000 stocks registered on Indian stock exchanges.
As a non-market linked investment product, the P2P segment has the ability to generate higher returns. If you’re inclined towards P2P to lend money, check out LenDenClub’s P2P lending environment that has produced excellent historical returns and has become a go-to choice for Indians in the P2P industry.
QEP response and actions
While the essence of the above seven points boils down to a higher-than-normal degree of investor uncertainty, it also nurtures a more conducive environment for active management. Our approach is firmly rooted in the trade-off between value and quality, which leads to a range of themes across our portfolios that are well suited for a broad range of market environments (see table).
The key is to ensure exposure across most of these themes, ensuring that no single environment dominates strategy performance. Alongside being more selective at the stock level, a focus on quality will be important, as will ensuring a balanced approach to growth while avoiding overpaying.
- Given rising cost pressures and the ongoing disruption to supply chains, we are currently dialing up the importance of margins in our quality framework. In practical terms, this means stressing our view of quality for companies that have historically been vulnerable to margin compression in favor of prioritizing those with stable and ideally rising profit margins where available. The starting point is also critical as those companies with a stronger margin buffer are clearly better placed to weather the potential storm. Having balance sheet flexibility is also important in terms of preferring those companies that can afford to absorb temporary cost pressures. Given that “real- time” adverse trends in margins are embedded in analyst forecasts, it may also suggest being more aware of the direction of short-term analyst EPS revisions. However, we are also conscious that we are past the peak of the current earnings cycle and analysts are almost certainly too optimistic at present. In response, we are scenario-testing our quality models to ensure that there is a sufficient margin of safety between structural and cyclical winners. This is a key research focus for the team at present.
- Without being alarmist, we are also attempting to recessionproof our portfolios by being more cautious on companies employing a high degree of short-term funding, effectively raising the financial strength bar. For example, there are plenty of examples of very cheap retailers and stocks within emerging markets that have had to survive on very high levels of shortterm debt in order to survive the Covid-19 crisis. If economic demand does disappoint, the goal posts for these stocks will have moved again and the chances of government support are not guaranteed. Scanning the wider investment universe provides more scope to identify the best opportunities after weeding out the potential value traps.
- There will be few places to hide if equity markets do reprice but we urge being very discerning in areas such as staples, which generally struggle to pass on higher costs, particularly at a time when their bond substitute premium has eroded. A preferred defensive area in our view is healthcare, particularly pharmaceuticals, which have performed well recently but are in aggregate still trading on historically low multiples given their underlying quality. It is worth stressing again that the usual trade-off betweenvalue and quality is not as evident today and it is possible to build a value portfolio with a PE of 10x forward earnings with the same fundamental characteristics as the broader market, which is trading on a multiple of almost 18x.
- Within deep value, we continue to advocate a hedged approach with very selective exposure to cyclical areas(i.e., avoiding those with any signs of financial distress or deteriorating fundamentals, particularly those facing longer term structural headwinds) balanced against a broader array of higher quality stocks with adequate free cash flow and quality backed yield. These are the tangibles that will most likely be in demand against a weaker growth backdrop but having a broad approach to value with exposure to earnings, cashflow, dividend and asset-based valuation characteristics has been the best approach over time.
- A natural hedge to rising inflation within equities can be found in the resources industries, although sustainability considerations do limit the scope of significant allocations and stock prices have already adjusted sharply. We are more focused on best-in-class companies, i.e., those with credible carbon transition plans or those that already have stronger environmental credentials. In our more value-focused strategies, we are overweight across commodities as well as the closely associated marine freight stocks, which forms a natural hedge. These areas are still very cheap despite the structural tailwinds that have been in place for many months. We expect this overweight to persist for some time.
- As noted already, banks have come a long way from the profligacy of the pre-GFC era. Once again, it pays to discriminate and focus on asset quality. The banking stocks that we own are well capitalized. In Europe, banks were already trading on deep discounts to their book values even before recent events but given the balance sheet repair we have observed over the last two years , we remain selectively comfortable for now. Indeed, the recent de-rating of EU banks has in our view been indiscriminate, albeit not an unexpected overreaction in these circumstances (i.e., selling all stocks quickly rather than waiting for asset exposures to be reported).
- We will also continue to add to quality growth without overpaying, by focusing on companies with improving prospects that we regard as more durable during a period of rapid disruption. We have further supplemented our work in 2020 in identifying those companies with the best forward growth characteristics by incorporating measures of historical cashflow generation supplemented by R&D investments that are expected to be accretive. As noted, the multiple compression that has been evident in many of these overlooked stocks in recent years provides plenty of strong opportunities.
Geopolitical crises have historically provided a buying opportunity for equity-focused investors. However, it is less widely stated that the main caveat to the resulting “buy the dip” response is whether the crisis then goes on to precipitate a recession. This is still not currently a consensus view, but the odds have certainly declined. Moreover, the fact that Russia seems likely to remain isolated from the rest of the world for the foreseeable future does increase the risk of unprecedented retaliatory measures.
Clearly, the situation remains very uncertain and a high degree of caution is warranted. This need not derail the broader attractiveness of seeking out good value opportunities as the excesses of the 2017-2020 period have only partially unwound, although avoiding value traps will be even more important. The unusually high representation of defensive stocks trading on relatively cheap valuations means that investors do not need to head for the hills in search of safety.
Equities are currently far more sanguine than the bond market, which seems unlikely to persist. At the very least, the elevated level of uncertainty about the geopolitical and macroeconomic environment suggests that equities will be more volatile and prone to larger swings in sentiment. The view that the Fed is now playing catch-up feeds into this uncertainty.
As a final comment, we note that periods of moderate market volatility have historically provided a favorable backdrop to our diversified approach, as it tends to generate short-term opportunities. Being able to harvest excess market volatility by trading efficiently (little and often) may well be a bigger driver of relative performance this year than making less predictable top-down calls.