by Jason Voss, CFA
Lim Chow Kiat, CFA, group chief investment officer of the Government of Singapore Investment Corporation, the sovereign wealth fund, was given an unenviable assignment at 66th CFA Institute Annual Conference: tell us how to invest in a low-yield world — and in so doing, solve one of the greatest mysteries of our current environment.
Lim began by telling the story of how we got here. No, it was not because of the global financial crisis. We arrived in our low-yield world after traveling down a massive, 30-year credit expansion cycle. This was the result of a long disinflation trend stemming from Volcker Effects (named for the former U.S. Federal Reserve Chairman); supply shocks caused by a billion Chinese workers competing globally on the basis of low wages; and globalization. (This is what death by a thousand paper cuts looks like, by the way.)
OK, great, you might say, but how should I invest? Lim's answer is really quite simple: there are no easy answers! Still, that does not mean that nothing can be done. First, investors must recognize the necessity of preparing for the eventual reversal of the credit expansion cycle. That is, they must begin to prepare for the long-term, say 7-10 years out. With this assumption in hand, investors must next execute on a crucial combination of factors:
- Investment managers must tease out the systematic risks in the portfolio. Identify the exposure of the portfolio and of individual assets on big betas.
- Required returns must be adjusted, and adjusted downward in particular, as so much rides on these assumptions — from investor expectations, to asset allocation decisions, to what degree pensions are funded.
- Even without adjusting return expectations, it is time to review your investment approach. Particular emphasis needs to be placed on reconsidering the unchecked philosophy of the importance of short-term returns. If return expectations are shifted to the long-term, decisions gain greater clarity.
- Given the relative high prices of fixed income, investment managers must reallocate their portfolios toward longer-term, higher duration and higher convexity assets in step with changes in the yield curve. Investors should also consider purchasing tail insurance, but with scrutiny on the price paid.
- Investment firms and their managers must also watch portfolio costs.
You will notice a recurring thread to the above considerations. Yes, they are all defensive steps. So what about offense? Lim recommended that investment managers:
- Look at the technology space, with particular emphasis on e-commerce and e-tailing. Lim believes these businesses are finally gaining scale and, hence, returns on assets that are compelling.
- Invest in this century's mega-trend: the rise of the middle class in two almost-there, but-not-yet-quite-developed markets: China and India.
- Pay special attention to the significant opportunity in Asia that will be presented by a free-trade zone (the Regional Comprehensive Economic Partnership), which is expected to be implemented two years from now.
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