Ryan Boothroyd: Post-covid world holds opportunity for long-term LGPS investors

After a difficult period for the global economy and financial markets, Ryan Boothroyd takes a step back and considers some reasons for optimism for long-term investors.

Reading the financial press over the past 18 months has been a harrowing experience for investors. Covid-19 wreaked havoc on the global economy, driving up unemployment, disrupting international supply chains and leading to huge swings in assets prices.

Markets have recovered strongly since March 2020, but the spectre of Covid-19 remains. Share prices trade on the faintest hint of vaccination news and experts point to a plethora of financial and non-financial risks on the horizon.

Against this backdrop it is easy for investors to feel a sense of despair. However, not all is lost. While it is a challenging time to be a steward of capital, there are many reasons to look forward with optimism rather than a sense of impending doom.

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14 July 2021
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Supportive policy

Covid-19’s negative impact on the global economy was unprecedented. However, so was the level of policy support provided by governments and central banks.

McKinsey estimates that over $10trn was pumped into the system in 2020 via a combination of employment guarantee schemes, business support and central bank asset purchases. Over three times the size of the policy response to the Global Financial Crisis.

The cumulative impact of these policy measures should not be underestimated. Governments and central banks are providing a substantial safety net that is unlikely to be fully withdrawn for some time. Interest rates in particular are likely to remain close to zero, with markets expecting only a handful of rate rises in the US and UK over the next five years.

Amid the economic disruption, households have also managed to save. In the UK, households are sitting on an extra £170bn of cash. As economies reopen, this could provide a much-needed boost to consumer spending.

Counterintuitively, investors face one of the most supportive economic backdrops in recent memory. This is likely to be a sustained positive tailwind for company earnings, and with record low interest rates, provides the perfect opportunity for companies and governments to rebuild.
Opportunities

Despite a supportive economic backdrop, asset markets are historically expensive and future expected returns are low. Many commentators cite this as the key cause for concern for investors seeking to outperform long-term return targets.

However, summary statistics for popular benchmarks do not give the full picture. There are still interesting opportunities for active managers lurking below the surface.

Stocks that have traditionally been priced cheaply, relative to their peers, are historically attractive versus the market.

Many value stocks continue to be shunned by investors, yet the economic recovery and reopening could provide a positive inflection point for earnings, leading to a significant recovery in share prices.

In fact, this has already begun in the worst hit names. The key is to choose carefully, focussing on higher-quality companies that have been through a temporary setback, rather than those whose business models are in terminal decline.

At the other end of the spectrum, companies who can sustainably grow their earnings can justify their expensive price tags. If investors can select companies with enduring competitive advantages, who can sustain high growth rates for decades, starting valuation becomes much less significant. Just ask long-term investors in Amazon, Netflix or Alibaba.

While the past decade has a been a difficult period for active managers, the requirement for selectivity in a bifurcated market will provide opportunities to outperform a passive index.

Necessity is the Mother of Invention

The pandemic forced a decade of technological change on the world in a matter of months. This has numerous positive impacts for investors and wider society.

In healthcare, the funding and flexibility awarded to pharmaceuticals industry in the search for an effective vaccine accelerated decades of research.

The widespread success of the RNA vaccines has huge positive ramifications for our approach to fighting other diseases and responding to future pandemics.

Future vaccines will require funding from investors with the potential promise of a return on investment and a contribution to positive social good.

Elsewhere, the acceleration is opening up new and interesting markets for investors to target. For example, the continued shift to cloud computing to facilitate effective home working provides opportunities in data centres, service providers and host of related industries.

Such innovations are happening across sectors and asset classes. One area that looks particularly interesting for long-term investors is the huge commitment to upgrade global infrastructure.

This is likely to result in an array of attractive, long-duration investment opportunities to supplement traditional fixed income as a portfolio diversifier.

Embracing climate risk

True long-term investors should be concerned about risks that could impact their beneficiaries well into the future, not just over the next 12 months.

Given the time horizon of the LGPS, future disruption from climate change should be at the forefront of long-term risk planning as it has the potential to transform the lives of those taking pensions in 50 years’ time.

The world has a long way to go to produce a sustainable version of modern life, however investors are starting to allocate serious capital to emissions reducing technologies and are increasingly refusing to fund fossil fuel extraction.

Large and consistent investment in green technology and targeted engagement with legacy energy providers will be critical to mitigate future climate risk for members. The good news is that we appear to be reaching a tipping point in the financial market approach to tackling climate change.

Looking Ahead

There are always risks on the horizon and it is fair to say that in the current climate there may be more hazards ahead than usual.

However, investors should not despair. Looking forwards, we face the prospect of a strong economic tailwind and a widening universe of new and interesting investment opportunities to exploit for the benefit of our members.

Ryan Boothroyd is portfolio manager at Border to Coast Pensions Partnership.

trading screens photo by Jason Briscoe on Unsplash

Netflix photo by Caspar Camille Rubin on Unsplash

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