Charity Investment Annual 2019 - Inescapable investment truths for the decade ahead - Cazenove Capital
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Charity
Investment
Annual 2019
Inescapable
investment truths
for the decade
ahead
Perspectives from
Charles Prideaux Keith Wade
Global Head of Product Chief Economist,
and Solutions, Schroders Schroders
Helen Stephenson
Sarah Williamson
Chief Executive,
Chief Executive,
Charity Commission for
FCLT Global
England and Wales.
Contents
Investment Thoughts
02 Inescapable investment truths for the decade ahead
14 Focusing capital on the long term
16 Fossil fuels: Divestment or dialogue?
19 Charity Responsible Multi-Asset Fund
Sector Thoughts
20 Charity Finance Roundtable: Foundations and the long term
24 NCVO UK Civil Society Almanac
25 ACF Foundation giving trends
26 Charity Investment Practice
Governance Thoughts
27 The six trustee duties
28 Public attitudes to charity - and why they matter
Welcome
Welcome to our fifth Charity Investment Annual. Once again we have pulled
together a collection of interesting articles that we believe are useful reading for
long-term charity investors. We capture some current talking points and
cover updates in regulatory and investment thinking that may be relevant to
the management of your charitable assets.
Giles Neville
Head of Charities
1
INVESTMENT THOUGHTS
Charles Prideaux Keith Wade
Global Head of Chief Economist,
Product and Schroders
Solutions, Schroders
Inescapable
investment truths
for the decade
ahead
There is no certainty in investment, but Economic forces and regions. In the eurozone, Japan and
there are areas where we can have very China there will be an outright fall in the
Looking beyond the near term,
strong conviction about the outlook and number of workers, as shown in chart 1.
demography has a disproportionate
the consequent challenges they pose These forecasted changes are largely a
impact on the economy. The key factors
to investors. result of declining global fertility rates.
are growth in both the labour force and
It seems clear to us that what we’ve in productivity. They define the supply
2. Poor productivity growth
got used to over the last few years is side of the economy and its ability to
very different to what we have to get sustain growth without causing inflation How efficiently the labour force – and
accustomed to in the future. to accelerate, or for significant imbalances other inputs – convert their efforts into
to build up (factors that typically signal the economic output is also in question. Since
We have identified a number of economic
end of an expansion). Actual output can the global financial crisis, improvements in
drivers and disruptive forces we think will
and will deviate from this in the short run, productivity have slowed across developed
shape the investment landscape ahead
for example through an easing of fiscal economies and much of the emerging
of us. These encompass demographic,
policy, but over longer periods growth is world. Looking ahead, we see some of
political, environmental and technological
constrained by the supply side. the drags on global growth fading as the
factors, which we believe will create both
financial system normalises. Therefore,
threats to and opportunities for our clients
1. Global labour force growth will our assumption is for output-per-head to
over the next 10 years. They represent our
decline recover over the next decade towards the
‘inescapable truths’.
levels that prevailed before the crisis.
A growing pool of employment helps
push the economy along. But the labour Our expectation for productivity growth
force will grow more slowly over the next over the next ten years in developed
decade across all the major economies markets is broadly in line with the average
2
Chart 1: Total number of workers is forecast to fall in eurozone, Japan and China
Labour force growth (actual and projected), % p.a.
2.0
1.7
1.5 1.4
1.0 1.0 1.0
0.6 0.5
0.5
0.2 0.1
0.0 0.0
-0.5 -0.3
-0.5 -0.6 -0.7
-1.0
US Euro 3 Japan UK Brazil China Emerging
markets
Last 20 years Next 10 years
Source: US Census Bureau, Oxford Economics, Schroders Economics Group.
Note: Last 20 years = 1997–2017, Next 10 years = 2018–27F. Emerging markets includes China, Brazil, Russia, India,
Mexico and Korea. Euro 3 refers to Germany, France and Italy.
Chart 2*: Productivity hopes rest on emerging markets
Productivity growth (actual and projected), % p.a.
Developed markets Emerging markets
5 10
9 8.6
7.9
4 8
7
3 6 5.4 5.5
2.4 5.0
2.1 5 4.2
1.8 1.8 4.0
2 1.6 4
1.5 1.31.51.3 3
1.1
1 0.7 0.7 2 1.6
1 0.8
0 0
US Euro 3 Japan UK Brazil China Emerging
markets
Pre-crisis 1997-2006 Post-crisis 2007-2016 2018-27F
experienced since 1997 (chart 2). The *Source: US Census Bureau, Oxford Economics, Schroders Economics Group.
emerging markets face a natural decline Note: Emerging markets includes China, Brazil, Russia, India, Mexico and Korea. Euro 3 refers to Germany, France and Italy.
The forecasts included should not be relied upon, are not guaranteed. Our forecasts are based on our own assumptions
as “catch up” growth fades and the
which may change. Forecasts and assumptions may be affected by external economic or other factors.
economies make fewer gains from the
adoption of new technology – the so-called
technological frontier. Still, emerging
markets may offer greater productivity
gains for the foreseeable future than their Chart 3: How demographics are changing
developed market counterparts. Life expectancy (actual and projected)
Years
3. Ageing populations 90
85
81
83 82 84 82 83
The slowdown in labour force growth 80 77 79 79 81 78 77 78
will go hand-in-hand with an ageing of 71 73
70 70 69
the population, a consequence of rising 66
longevity (chart 3). Greater life expectancy 60
will put pressure on government finances
50
and compound the effect of slower 45
working population growth. It will weaken 40
per capita consumption and investment, 30
and hence overall growth. The ageing US Germany Japan UK China
population may also temper the recovery 1955-60 2000-05 2015-20 2025-30f
in productivity growth.
Source: UN 2017.
3
INVESTMENT THOUGHTS
Chart 4: Global economic growth 4. Gloomy global growth picture
Global GDP growth actual and projected These factors combine to give an outlook
(local)% p.a. of relatively slow GDP growth for the world
10 9.3 economy in line with the demographics
9
8 (chart 4). Each of the major regions is
7 6.6 expected to experience weaker growth
6
5 5.1 over the next 10 years than the average
4 4.1 4.2
achieved since 1996. Such a backdrop,
3 2.4
2 2.1 combined with continuing social
1.7 1.4 1.3 0.8 1.7 2.1
1 0.6
0
inequality, is likely to create more political
-1 uncertainty.
1997- 2018- 1997- 2018- 1997- 2018- 1997- 2018- 1997- 2018- 1997- 2018- 1997- 2018-
2016 2027 2016 2027 2016 2027 2016 2027 2016 2027 2016 2027 2016 2027 Emerging markets will continue to increase
US Euro 3 Japan UK Brazil China Emerging
markets their share of global GDP. This is largely
Labour force Productivity Projected a consequence of the higher productivity
Source: Source: US Census Bureau, Oxford Economics, Schroders Economics Group. Euro 3 refers to Germany, growth associated with economies at
France and Italy.
an earlier stage of development. Higher
incomes will bring a growing middle class
Chart 5: China’s influence on the world continues to climb and increasing demand for financial assets.
% share of world Within this, the outlook for China will be
40 critical, as we discuss below.
35
GDP growth is important for determining
30 the overall size and income levels of
25 economies, but for equity markets a key
20 driver of returns over the medium term
is productivity growth. The latter relates
15
more closely to earnings per share as it
10
adjusts for the increased input of labour
5 and capital1. On this basis, if productivity
0 growth improves compared to the recent
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 past it should support better corporate
China US China projection US projection earnings and equity returns.
Source: Thomson Datastream, Oxford Economics, Schroders Economics Group.
5. China will be critical
Chart 6: How debt levels have grown China’s rise has been astonishing and
the key driver behind emerging markets’
Debt (indexed, Dec 01 = 100)
growing share of global GDP, more than
345
tripling its share since joining the WTO
in 2001. However, China now faces a
295
decisive transition period. Demographic
challenges lie on the horizon as its working
245
age population enters decline. More
195
immediately, policymakers must find a way
to address excessive borrowing and poor
145 asset quality in the banking system while
also reducing the reliance on investment
95 and heavy industry.
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Government Households Non financial corporates Financial corporates
1
As it does not allow for investment/ shareholder dilution,
GDP growth does not relate well to equity market returns.
Source: BIS Data.
4
Complicating matters further, part of this Chart 7: What is the new normal for interest rates?
effort, “Made in China 2025”, has roused Average annual % real interest rate (short-term interest rate minus inflation)
the ire of the US. China’s plan to dominate %
the global market in new technology
5 4.5
industries – robotics, new energy vehicles
4
and artificial intelligence (AI) among 3.1
3
them – poses a clear competitive threat 2.2
2
to the US and a challenge for the global
1 0.7
economy. 0.4
0
This helps explain the stance taken by -1
-0.8 -0.8
the US, and means that tensions are -2 -1.6 -1.8
unlikely to subside. The existential fear -3
in the US over China’s growing high-tech 1900 - 1980 1981 - 2008 2009 - 2017
competitiveness will probably result in US UK Europe
more localisation, or even a “splinternet”
Source: Dimson, Marsh & Staunton, Credit Suisse Global Investment returns Yearbook 2018.
that divides trade in high tech goods and
services along regional lines. In April 2018,
the Federal Communications Commission tightly regulated banking sector will also 7. Interest rates will likely remain low
passed rules making it difficult for US firms constrain the willingness and ability of
Interest rates will be higher than today’s
to buy Huawei equipment, and China’s ZTE individuals and firms (particularly small
exceptionally low levels, but are still likely
was temporarily shut down by US export and medium sized enterprises/SMEs) to
to be relatively low by the standards of
restrictions, which cut off supply of key take on more credit.
pre-crisis levels. Quantitative estimates
components not available elsewhere.
These factors suggest that demand, like of where interest rates will settle in the
Beyond this, China’s efforts to reduce supply, will grow moderately in future. long run vary, but recent comments from
debt levels, or at least slow the rate of This would reduce both the likelihood policymakers2 suggest the equilibrium
borrowing, has implications for global of inflation accelerating above target level3 for the US and UK is around 0.5%
growth. The Chinese stimulus response and the need for aggressive rate hikes in real terms, meaning 0.5% above the
to the global financial crisis was worth by central banks. Inflation is also likely rate of inflation. This would be higher
some 20% of GDP. A similar effort simply to be contained by ongoing structural than today’s levels where interest rates
looks unaffordable today. That China has factors, such as the disinflationary effect are below inflation, but below the levels
also accounted for the lion’s share of the of international competition on prices that prevailed before the financial crisis.
growth in global debt would also suggest and wages and the deflationary impact of The equilibrium rate will vary from
that, even absent a crisis, global growth disruptive new technology. market to market but taking a longer run
would struggle unless another similarly perspective, the new level would be similar
These effects may be tempered by populist
willing debtor can be found as China in our view to the average between 1900
politics, with measures such as tariffs and
retrenches. and 1981, some 1% to 3% below pre-crisis
restrictions on immigration. It is likely
levels (chart 7).
that we have passed the peak in terms
6. Global inflationary pressure will be
of pressure from globalisation, but the
limited
overall impact of these structural factors is
The outlook for inflation will depend on still likely to be disinflationary.
how supply in the world economy grows
For example, the effect of robotics and
relative to demand. All things being equal,
artificial intelligence (AI) on the labour
a weaker supply side should mean more
market is only just beginning to be felt and
capacity constraints and hence higher
will create a new deflationary wave as the
and more volatile inflation. However, the
effect of globalisation ebbs.
same factors that will constrain future See: The future fortunes of R-star: are they really rising?
2
John C. Williams FRBSF, 21 May 2018 and the Bank of
supply will also weigh on demand, with Overall, we would see the low growth England Inflation report, August 2018.
spending likely to slow in line with weaker environment going alongside low inflation
3
The equilibrium rate is the interest rate that would
pertain when the economy is at equilibrium, meaning that
labour force growth and an ageing and interest rates. unemployment is at the natural rate and inflation is at the
population. High levels of debt and a more 2% target.
5
INVESTMENT THOUGHTS
Chart 8: Schroders’ forecasts for stock market returns Economic forces: the
Historical (2007–2017) vs. future 10 year Equities return expectations (2018–27)
% p.a. (local)
investment implications
10 9.5
8.5
The broad macro-economic environment
9
8 we have described is not unlike that
7 experienced since the global financial
5.8 5.6
6
5 4.1 4.5 crisis, where equity and bond markets
3.8 3.6 3.5
4 3.0 have performed well despite low growth
3
2 and inflation. However, during that period
1 markets had the tailwind of very loose
0
US Eurozone UK Japan Emerging Mkt monetary policy as central banks kept
Last 10 years Next 10 years interest rates well below inflation, a factor
that has supported higher valuations.
Source: Schroders, June 2018. The forecasts included should not be relied upon, are not guaranteed and are
provided only as at the date of issue. Our forecasts are based on our own assumptions which may change.
Forecasts and assumptions may be affected by external economic or other factors.
As discussed above, we expect a
normalisation of monetary policy with
interest rates moving back above inflation
Chart 9: Investors’ expectations for returns and bond yields experiencing upward
The 2017 Global Investor Study highlighted high annual return expectations for the next five years pressure as quantitative easing (QE)
unwinds. Cash and government bonds
40% 37%
37% will become more attractive, but will still
35% 34%
offer limited real returns and consequently
30% income-seeking investors will continue to
26%
25% search for yield.
21%
20%
1. Greater focus on corporate earnings
15% 13%
as volatility rises
10% 8% 8%
4% 4% 5% Looking at stock markets, as interest
5% 3%
0%
rates rise investors will be less willing
Don’t
or
0%
1–4% 5–9% 10–20% 20%+
Don’t 0%
or loss 1–4% 5–9% 10–20% 20%+ to pay high valuations for stocks. Stock
Know loss Know
Europe Global market returns will increasingly be driven
by earnings growth and by payouts
Source: Schroders’ 2017 Global Investor Study 22,000 investors in 30 countries.
to shareholders (via dividends and
buybacks). Volatility in financial markets
Chart 10: Schroders’ forecasts for government bond returns is also likely to be higher as interest rates
Historical (2007–2017) vs. future 10 year return government bond expectations (2018–27) normalise and official asset purchases are
unwound. Although the macro backdrop
% p.a. (local)
may be subdued, central banks will
9 8.3
8 not be as active in suppressing market
7 6.6 volatility through highly responsive policy
5.9 6.0
6
4.6 responses, i.e. the so-called central bank
5
4 ‘put’ is likely to fade.
3 2.8 2.5
2 1.2
Increased political risk will also create
1 0.8
0.0 bouts of higher volatility, as we have seen
0
US eurozone UK Japan Emerging mkt recently with the US administration’s trade
Last 10 years Next10 years policy.
Source: Schroders, June 2018. The forecasts included should not be relied upon, are not guaranteed and are Against this backdrop, equity and
provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. bond markets will put greater focus on
Forecasts and assumptions may be affected by external economic or other factors.
Past performance is not a guide to future performance and may not be repeated. corporate profitability. Low GDP growth
6
does not necessarily imply weak profits This analysis describes our central view of Disruptive forces
growth. As noted above, productivity is markets over the medium to long term,
a better indicator of profitability and the but we recognise that the world economy 1. Market disruption
anticipated improvement in developed faces a series of challenges which could
markets will help in this respect. The lead to significantly different outcomes. Changing patterns of finance
continuation of relatively high productivity
In the next section we look at four One factor which is likely to present
growth in the emerging world will also
disruptive forces which are prevalent opportunities for investors is that
support earnings in these markets.
and are not going away. They are likely banks are likely to play a reduced role
Alongside productivity, corporate earnings to affect the investment landscape over in financing economic activity, as the
performance will also depend on the the next decade and we examine the sector operates under stricter regulatory
ability of business to maintain the level associated opportunities and threats. constraints. While this is one of the
of profits as a share of GDP or national potential checks on future growth, it will
income. These have risen significantly encourage the provision of alternative
in recent years and are now under sources of funding. This may be in the
pressure from growing economic and >20K investors with >€10K invested savings.
4 form of debt or equity, but may create
political factors, which point to a greater
proportion of GDP going to labour in the
form of higher wages and compensation. Chart 11: Rising alternative sources of funding
Private capital AUM by asset class
2. Returns from market indices may be $bn
limited 5,000
The net result of these cross currents is 4,000
likely to be lower returns on stock market
indices, or beta, compared to the recent 3,000
past. Our return expectations for the
2,000
next ten years are summarised in chart 8
and show that with the exception of the 1,000
emerging markets, all equity regions are
expected to deliver lower returns over the 0
Dec 07 Dec 08 Dec 09 Dec 10 Dec 11 Dec 12 Dec 13 Dec 14 Dec 15 Dec 16 Jul 17
next ten years than in the previous ten-
year span. Private equity Private debt Real estate Infrastructure Natural resources
Our research also shows investors are Source: Prequin Global Private Debt Report 2018, data from 2007–2017.
hoping for far greater returns, shown
in chart 9. The Schroders 2017 Global
Investor Study4 surveyed more than Chart 12: Value of assets in central banks’ balance sheets
22,000 investors in 30 countries. It found $trn
the typical investor expecting annual Forecast
25
average returns of 10.2% over the next
five years. 20
The gap between forecast returns
15 $15.7trn
and history is even more dramatic for
sovereign bond markets, shown in chart
10
10, than for equities. In the words of the
London Underground: mind the gap. 5
The implication is simple: there will be
0
greater need for active fund managers 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
who can generate alpha – i.e. who can
Eurozone Japan Switzerland China US UK
beat the market – in the period to come.
Source: Thomson Datastream, Schroders Economics Group. 15 August 2018. Full data to Q2 2018.
7INVESTMENT THOUGHTS
opportunities for private capital (see 2. Technological disruption 3. Environmental disruption
chart 11). Private capital refers to money
provided to a business that does not come Changing business models Rapid action needed
from an institutional source, such as a
Technological progress is already a feature Our views of the future are complicated
bank or government entity, nor through
of our projections in driving productivity by growing tensions between the real
selling on a stock exchange. Economies
and long run growth. However, technology economy and the natural environment,
and regions that have been particularly
also creates unique challenges for and climate change in particular. The
dependent on banks for funding, such
investors through its tendency to disrupt challenge has been centuries in the
as the EU, will shift toward other forms
existing businesses and create winners making, but remedial action will have to be
of funding. We expect the corporate
and losers. By breaking down barriers to far faster to avoid its worst impacts.
bond market to expand along with
entry, new opportunities can be created.
private equity and alternatives such as Larger, wealthier populations put more
peer-to-peer lending (loans provided by Mark Carney, Governor of the Bank of pressure on Earth’s finite capacity to meet
individuals) and crowdfunding. Indeed, England, recently commented: “In a expanding consumption or to absorb
there’s nothing alternative now about hyper-connected, capital-light world, the the damage it creates. As one measure,
alternatives. They’re now the norm. future may increasingly belong to small the Global Footprint Network tracks the
and medium sized firms with platforms…. world’s use of ecological resources, relative
The end of QE giving them direct stakes in local and to its capacity to supply those resources6.
global markets. Connections can be made That analysis implies the world has a
The US Federal Reserve is already in the
between small businesses in Scunthorpe consumption footprint more than 50%
process of reducing the assets on its
and their clients in Shanghai, and between larger than its capacity, an environmental
balance sheet, which were acquired
households in Bassetlaw and Bangalore5”. deficit that has been widening for around
through QE. We expect central banks in
half a century.
the UK, Japan and the eurozone to move Clearly, picking those who are on the
in the same direction in coming years, to right side of technological progress Carbon emissions and the challenges
begin selling the assets they bought (see will continue to be key for portfolio climate change poses are the largest
chart 12). This will increase the supply of performance. component of that footprint, and have
government and high-quality corporate escalated social and political agendas.
bonds to the private sector, as these Displacement of jobs Since the industrial revolution, the world
have been the principal assets purchased economy has grown in lockstep with
More generally, new technology can also
during these programmes. rising energy demand and fossil fuels
be a double-edged sword. It can bring
in particular. That growth in turn has
The process of unwinding QE will be slow greater efficiencies in production, but
pushed up concentrations of greenhouse
and gradual, but will be welcome given also increase displacement in the labour
gases in the atmosphere by around 50%.
the present shortage of these less risky market as traditional occupations become
Global temperatures have risen by one
assets and future demographic profile obsolete. The future for the three million
degree Celsius over the same period, with
(with more retiring savers seeking financial drivers of long-distance vehicles in the US,
a further 0.6 degrees almost assured7.
security). As mentioned previously, rising for instance, looks bleak.
Global leaders have committed to keep
rates will likely push up bond yields and
While increased international trade has long run temperature rises below two
weigh on stock markets, as the interest
received much of the blame for job losses, degrees8, which means rebuilding the
rates available on bonds increase, stocks
new technology has been just as powerful energy infrastructure underpinning the
generally become less attractive. Such
in terms of its labour market impact. As world economy.
pressures may be particularly acute in the
the fourth industrial revolution gathers
eurozone, where official asset purchases
pace, the increased use of robotics and AI
(QE) have significantly depressed yields. 6
https://www.footprintnetwork.org/resources/data/
will affect a wider range of professions. 7
The approximately 40 year lag between emission release
and temperature changes mean further temperature rises
The problems of inequality may worsen as can be effectively predicted based on emissions already
a consequence, with the potential to bring released
8
The agreement reached in Paris in December 2015: https://
even greater political disruption. unfccc.int/process-and-meetings/the-paris-agreement/
the-paris-agreement. This is not a stretch goal; it’s the level
at which there is a 50/50 chance of “catastrophic climate
5
From Protectionism to Prosperity, 5 July 2018 https://www.bankofengland.co.uk/-/media/boe/files/speech/2018/from- change” according to analyses summarised by the OECD,
protectionism-to-prosperity-speech-by-mark-carney.pdf?la=en&hash=49A74832C30C95D5284088BA0D0DB7EA0B2E91F2 IIPPC and others.
8Unchecked environmental damage
will have severe economic and social Chart 13: Investors’ sustainability priorities
consequences How investors rate the importance of the issues that they want fund managers to act on
0 5 10 15 20 25 30 35
Current efforts fall far short of that goal. In
2017, we introduced the Climate Progress Ending bribery and corruption 7.7 7.9 8.3 7.9
Dashboard to track climate action across
Pollution from operations/use of renewable energy 7.4 7.6 7.9 7.6
a wide range of indicators. It currently
points to long run temperature rises Treatment of the company’s workforce 7.2 7.4 7.8 7.4
around 4 degrees9. Should that continue,
Climate change 7.3 7.2 7.5 7.3
sea levels would rise by around one metre.
Some regions would see 50% declines in Selling unhealthy or addictive products 6.8 7.1 7.3 7
water availability, while others become
Diversity of the company’s workforce 6.4 6.9 7.3 6.7
flooded. Oceans would become 150%
more acidic, devastating marine life. 0 = not at all - 10 = extremely Europe Asia Americas Global
The social and economic impacts of that
disruption would be unavoidably huge.
Our own analysis has estimated the impact globe 76% of investors felt that sustainable Unfortunately, a failure to deal with the
on global output at anywhere from a few investment was more important than five pressures on public finances will mean an
percentage points of loss to 50% or more years ago. In tandem with this, 64% of increasing risk of crisis in countries with
by the end of the century. all investors and 75% of millennials have high public debt and poor demographics.
revealed that they have increased their Governments are pursuing policies to
While inaction implies significant long-
sustainable investments within the past mitigate these effects (such as raising
term risks, steps to avoid the worst
five years. retirement ages), but such pressures
effects of climate change will also prove
are already attracting the attention of
necessarily disruptive. Cutting global Behind these headline figures, the study
sovereign ratings agencies.
per-capita emissions by four-fifths by also revealed individual motivations for
2050 will require far tougher policy sustainable investing, highlighting the It is possible that such trends will open up
intervention than we have seen to date. specific factors where they wanted fund opportunities for investors. For example,
Our modelling of the financial implications managers to make a difference (chart 13). the need to finance public infrastructure
of policies tough enough to contain spending could allow the creation of
temperature rises below two degrees 4. Political disruptions long-dated bonds with a secure income
implies 10–15% of the value of global stream – an attractive investment for
companies could be lost10. Government finances will come under ageing populations. Innovation is needed
pressure to meet rising healthcare demands and,
It seems unavoidable that a combination
as people extend and shift careers, there
of the physical damage climate change The rise of populist political parties and
will be greater demand for education and
creates and the impact of steps to mitigate leaders has become a key feature in
training. Technology will play an increasing
its impacts presents a complication to Europe, the US and parts of Asia recently.
role and private sector involvement in all
future economic or investment views. The economic outlook described above
these areas could be key.
We have invested in analysis and tools would reinforce this populist trend, as we
to monitor, measure and manage that will see government finances undermined
risk; there are no simple shortcuts or as slow growth cuts tax revenues and
established models, but recognising a new boosts expenditure on benefits. Ageing
source of risk seems unavoidable. populations will increase pension spending
and demand for healthcare, adding to
Investors increasingly care about the pressure on government borrowing
environmental issues as dependency ratios rise. Consequently 9
https://www.schroders.com/en/about-us/corporate-
the ability of governments to meet voter responsibility/sustainability/climate-progress-dashboard/
Results from Schroders’ 2018 Global 10
https://www.schroders.com/en/about-us/corporate-
expectations will become increasingly
Investor Study11 revealed that consumers responsibility/sustainability/climate-progress-dashboard/
challenged, thus further feeding populist carbon-var/
have become more aware of sustainability
unrest. 11
>20K investors across 30 countries with >EUR10K invested
in their investment choices. Across the savings.
11INVESTMENT THOUGHTS
Growing pressure on individuals regimes, thus putting more pressure on
government finances whilst boosting
On an individual basis, pressures on
corporate earnings12.
government funding of healthcare and
pensions means that people will have Policies to temper the impact of
to take greater individual responsibility. globalisation through restrictions on
Against this backdrop, people living longer trade, immigration and capital flows are
should result in growth assets being held increasingly likely to emerge. Greater
for longer periods to support retirement. redistribution through taxation and other
There are likely to be more demands on policies such as increased state control
the retirement account as people have to of industry are also probable. The only
fund old age care as well as their income. certainty is that political risk will be a much
There is also a potential knock-on impact more significant part of the investment
from lower returns as pensions are more landscape.
likely to be underfunded at retirement,
meaning people are likely to have to work
for longer. Disruptive forces: the
However, none of these are particularly investment implications
palatable options and we recognise that
Our central analysis suggests that we
greater private sector involvement may
are moving to a world of lower growth
not occur as the increase in populism
and lower returns, consistent with the
leads governments to pursue alternative
demographics and productivity trends.
solutions.
Equities are still expected to outperform
bonds and emerging markets outperform
The rise of populism will increase
developed, but the absolute level of
political complexity
returns is likely to be lower than in the
Populism has been fuelled by stagnating recent past. In addition, we would expect
living standards for a large proportion of volatility to be higher as monetary policy
the population and, although we expect normalises and the central bank “put” on only and are not a recommendation to
national incomes to rise, it is likely that markets (mentioned above) expires. buy and/or sell. Sectors that offer higher
median incomes will continue to struggle. levels of returns generally carry higher
Forecasts included should not be relied risk, no investment is risk free.
In real terms, the median household upon, and are not guaranteed. References
income in the US was the same in 2016 as to sectors are for illustrative purposes
in 2000, despite an increase in real GDP
over this period of 38%. Chart 14: No progress in European living standards since 2008
Gains have been skewed toward the upper Net real median incomes (2016 prices in euros), Index (100 = 2008)
end of the income distribution (i.e. the 120
wealthiest), while the lowest earners (those
110
in the lower quintile) have experienced
absolute declines in real income. The 100
picture is similar for Europe (see chart 14),
90
although less pronounced due to the more
redistributive tax systems. 80
Globalisation is seen as one of the culprits
70
here, along with technology and the
effects of central bank policy on asset 60
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
prices. The spotlight has also fallen on
the ability of multi-national companies Eurozone recessions Germany Spain France Italy United Kingdom
to divert income to favourable tax Source: Thomson Datastream, Schroders Economics Group.
12Expect a greater range of market drivers determined by the ability of firms to reap return, active stock selection and risk
the benefits and anticipate these changes. management will be critical in meeting the
The shift toward monetary policy
goals of investors over the next decade.
normalisation, particularly the end of All of this analysis suggests we can expect
QE, will also create a greater range of greater divergence in performance across As we enter the next phase of the
market drivers. It has always been the asset classes and within markets, with post-global financial crisis era,
case that macro factors alone do not greater focus on individual or idiosyncratic these “inescapable truths” can help
drive all markets. Many stock markets are drivers. While financial markets may offer guide investors through a time of
skewed toward particular sectors, or have more subdued returns and become more unprecedented disruption.
significant overseas exposure and do not volatile, the scope for alpha generation
The value of investments and the income
reflect the domestic economy. As central – to beat the market – and diversification
from them may go down as well as up and
bank influence wanes, such factors will should remain significant. Being aware of
investors may not get back the amounts
come to the fore. these trends is important and highlights
originally invested.
the advantages which active asset
Consequently, there will be a greater
management can provide to investors13.
focus on profitability and earnings growth
rather than valuation shifts as drivers of
Conclusion
returns. Within markets, profitability will
be determined by the ability of a firm After almost a decade of strong returns
to maintain its market position amid many investors have become complacent
increasingly disruptive trends. Shifts in about the outlook. This assessment
politics, markets, technology and the suggests that in a more challenging 12
For more on this see here. 13For more on the case for
environment are four we have focused future environment factors such as asset active management see https://www.schroders.com/en/
on here and stock performance will be allocation, access to multiple sources of insights/economics/the-case-for-active-investing
13INVESTMENT THOUGHTS
Focusing capital
on the long term
The benefits of long-term investing are “But if we are talking about an educational
demonstrable and understood. Why institution with a history stretching back
then is it so hard? 400 years, for example, its endowment
needs to be invested on the basis that it
The world’s capital markets owe their
will fund another 400 years and more. This
existence to the need for long-term
is an almost limitless time-horizon. It calls
savings, Ms Williamson argued.
for something very different.”
Sarah Williamson
“The reason markets exist is because
Chief Executive, A long-term approach carries
individuals, charities and other institutions
FCLT Global demonstrable benefits not just at the level
want to find a way of saving for long-term
of the portfolio creation and management.
goals,” she said. “They need long-term
If the underlying investments are
ways to preserve and build value.”
themselves businesses managed toward
Investment professionals claim to take a longer-term goals, their returns are also
long-term view, she said, where in reality demonstrably higher.
this was less often the case.
Ms Williamson cited research undertaken
“The instinct of most professional investors and published last year by McKinsey
Cazenove Charities’ fifth annual Charity is to be long-term. The clear consensus is Global Institute, the research division
Investment Lecture took place in London in that it’s right to buy into businesses where of the consultancy group. It created
May. This year’s guest speaker was Sarah management takes a long-term view, a systematic measure with which to
Williamson, a finance professional whose and it’s right for you to be a long-term categorise hundreds of quoted businesses
career and experience give her unique shareholder yourself. But if we all know as operating on either a predominantly
insights into investment processes and this – and can see the data that lies behind long- or short-term basis. It then
practices of institutional investors, including it – why is it so hard to do in practice?” compared their financial performance on a
charities. number of measures over the period 2001
One explanation Ms Williamson
to 2014.
Much of her career was spent with volunteered is that human lives are short
Wellington, the global fund manager when compared to some institutions’ It found, on average, that businesses
operating from Boston. In 2016 Ms objectives. Fund managers and trustees focused on the “long-term” grew their
Williamson moved from there to become want to see returns that match career revenues by almost 50 per cent more than
chief executive of FCLTGlobal, a not-for- expectations (“how long will you be in that their “short-term” rivals over the period.
profit organisation which exists to promote role?”). Private investors may have other The firms with a long-term approach
– through research, publications and objectives linked to life stages, such as also invested more in research and
other initiatives – long-term behaviours in paying for their children’s education or development than their rivals, and added
investment and business decision-making. saving for retirement. These objectives are more jobs during the period.
comparatively near-term.
She used her speech to communicate some of The report, Measuring the economic
the key advantages that certain institutions, “Real people do not have a timeless impact of short-termism, concluded that
including charities, enjoy over other types horizon,” she said. “They want to see had all the 615 firms analysed followed the
of investor. What follows is a precis of her outcomes measured over shorter periods, “long-term” model, an extra five million
address. say three years or five.” jobs would have been added during the
14period. The cost to the US economy of This trend has grown over decades and
short-termism, it extrapolated, was thus shows no sign of reversing. Since 1966
around $1 trillion over the past decade. the number of companies listed on the
London Stock Exchange has fallen by
Ms Williamson said that portfolio
more than 70%*. In the US, a comparable
managers and business managers alike
statistics suggests the number of listed
were liable to respond to the same sort
companies has halved in just the past two
of behavioural prompts – in particular,
decades.*
certain types of pay structure. Shorter-
term targets result in shorter-term focus. Ms Williamson sees this as evidence that
“Incentives do what they say they do: they business growers are choosing non-public
incentivise,” she said. ways to raise finance, for example by
selling stakes to private equity investors. Harvard and Yale
“When benchmarks and incentives focus
on the nearer-term then we start to see This is helpful to longer-term investors, Ivy League colleges Harvard and Yale
the kind of behaviour that history shows such as endowment funds, because the manage between them endowment
professional and private investors are nature of private-equity holdings sits funds worth over $60bn. Just as
always prone to: they tend to buy the more comfortably with their broader these two institutions are ferocious
thing that just did well and sell the thing timeframes. But she highlighted a social rivals in terms of academic
that just did badly. In other words it’s the cost. If the wider investing public is standards and achievements, they
age-old blunder of buying at the top and excluded from participating in the growth are also fiercely competitive about
selling at the bottom.” of new businesses, disparities that we the investment performance of their
see now within developed economies will respective funds.
The liquidity advantage that comes with growth further.
a long-term approach And in recent years Harvard’s
The ultimate goal, she maintained, is for performance has lagged. According
Portfolios have differing liquidity mainstream savers to have access to liquid to the latest year of published
requirements. If there is a need to meet investments geared toward capturing results, Yale’s fund returned 11.3%
potentially large and unexpected expenses long-term returns. compared to Harvard’s 8.3%.
a fund must be able to sell assets at short
“If all the wealth creation is only available But it is not just a one-year
notice. This plays a role in determining
to the already wealthy, wealth dispersion phenomenon. Harvard, of which
the portfolio’s makeup. But liquidity has a
will continue to deteriorate.” Ms Williamson is an alumnus, has
price.
The headlines that prompt shorter- fallen behind Yale in the longer-term,
“People often fail to realise how much resulting in annualised growth over
term decision-making
they pay for their high levels of liquidity,” a period of several decades that
Ms Williamson said. The “price” is in the Another factor that impels short-term is approximately two percentage
form of the potential for higher returns behaviour is the scrutiny to which some points lower than Yale’s. Because
available from less liquid assets – such as fund managers’ performance is subjected investment gains are largely
property, infrastructure, private equity – by the Press and other commentators. reinvested, future “losses” arising
which are forgone. Many charities and other institutions, from a period of poor performance
however, are left alone in this regard, Ms can rapidly run to tens of billions of
Where the investors’ goals are truly long-
Williamson pointed out – which is helpful. dollars.
term, Ms Williamson pointed out, the need
for liquidity is lower – giving rise to a wider “Investors have to make decisions for Ms Williamson uses the comparison
range of suitable assets and potentially the right reasons, not because of public to illustrate the higher returns which
higher returns. relations,” she warned. result when portfolio managers
This advantage that charities and other “Your job is not public relations. You’re take a genuinely long-term view.
long-term investors can enjoy is, in fact, not there to think about quarterly Yale is a true long-term investor,
becoming more pronounced, thanks performance or even about the next three she maintains. And – at least until
to another trend in the market: the years. Your job is to think about the next recently – Harvard had failed
diminishing number of businesses that generation.” to capitalise on their long-term
choose to issue shares. investment horizon.
*Source: Schroders
15INVESTMENT THOUGHTS
Fossil fuels –
divestment or
dialogue?
Investors and asset managers have put thirds over the next three decades, which
increasing thought into how to respond is a clear challenge to producers. It implies
to climate change within investment that the world will need to cut fossil fuel
portfolios. As stewards of long-term production by 1% annually up to 20504, a
assets, how can we ensure that the funds sharp reversal from the 2% annual growth
we manage align with the commitments of the last thirty years.
global leaders made to limit the rise in
A number of foundations, university
long-run temperature to two degrees?
endowments and charity investors are
Climate change is a long term and part of this divestment ‘movement’,
escalating challenge for society. It will choosing to sell their fossil fuel holdings
affect the way we live and products we for a variety of reasons. Some may want
buy. Experts at Schroders estimate that we to show their moral disapproval, judging
are currently heading for a temperature that fossil fuel companies contradict their
rise of over four degrees (see Schroders mission. Some divest for financial reasons,
Climate Progress Dashboard1), so meeting believing that the intrinsic value of fossil
the ‘two degrees’ commitments will fuel assets are much lower than current
require significant change with profound market valuations - so called ‘stranded
implications for how we all live. assets’. For others, the act of divestment
itself is an attempt to influence public
At the forefront of the climate change
policy or reduce their own indirect carbon
debate are fossil fuel companies and the
emissions. Many universities are also
role that long-term investors can play in
feeling pressure from student groups,
encouraging the transition to a low carbon
where stakeholder influence can be a
world. Should we be making a moral
powerful force for change.
judgement about fossil fuel producers and Belinda Gan Emilie Shaw
selling our shares or using our rights as Whatever the catalyst, asset owners need Associate Product Portfolio Manager
shareholders to push for change? to consider the potential challenges and Manager, Cazenove Charities
practicalities of full divestment. Global Sustainability
A growing number of investors are
Schroders
responding to climate concerns by selling
The impact of divestment on asset
shares in fossil fuel producers. At $5.4
allocation and returns
trillion2, the value of investment portfolios 1
https://www.schroders.com/en/about-us/corporate-
that exclude fossil fuels has doubled in the Fossil fuel producers make up around 6% responsibility/sustainability/climate-progress-dashboard/
last two years and some voices in the EU of the global stock market and over 12% https://gofossilfree.org/commitments 28.02.18
2
3
https://www.eia.gov/energyexplained/index.
Parliament are recommending divestment. of the UK market5. Excluding an entire cfm?page=environment_where_ghg_ come_from
This is because most of the blame for sector impacts asset allocation, resulting in 4
Based on IEA scenario analysis, combining different fuels on
a contained energy basis.
climate change lies with man-made increased benchmark risk (relative to the 5
Source: Bloomberg 28th February 2018. Global index
greenhouse gas emissions, around 80% market) and potentially higher volatility. represented by MSCI AC World and UK market represented
by the FTSE All-Share
of which are from fossil fuels3. Limiting
Schroders research shows that over the 6
Available here https://www.schroders.com/en/uk/pensions/
temperature rises to acceptable levels insights/thought-leadership/demystifying-negative-
long-term the impact of exclusions on
means cutting those emissions by two- screening/?_ga=2.132815438.1771667345.1543775419-
investment returns is minimal. However, 1736664189.1537867554
16Screens have minimal effect on long-term returns But can be very influential over shorter periods
Cumulative returns of MSCI World Index with different One year rolling return of screened MSCI World Index
screens applied† relative to the full index†
1500% 4.00%
1200%
2.00%
900%
0.00%
600%
-2.00%
300%
0% -4.00%
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
MSCI World Ex fossil fuels Ex-tobacco
Ex-sin* Ex-weapons Ex-fur
Ex-alcohol Ex-gambling Ex-nuclear
Ex-pornography Ex-tobacco Ex-fossil fuels
Past performance is no guarantee of future results. Investors cannot invest directly in any index.
Source: Schroders; Datastream 30 June 2017. †Exclusions for fossil fuels and all sin stocks are based on 10% revenue cut off, as defined by MSCI. Exclusions for weapons, fur and nuclear are
based on business involvement, as defined by MSCI. *Sin stocks include tobacco, alcohol, gambling and pornography.
17INVESTMENT THOUGHTS
it can increase volatility in the short term. from the lower carbon content of their
Fossil fuel screens*
In the charts on the previous page we fuel relative to other options. Equally
compare the returns of the global equity companies with lower cost operations
market to a screened index. will be better able to withstand falling
consumption. Low cost producers biased
The exclusion of fossil fuels has had a 104 357 towards gas production sit towards the
significant impact on relative returns in 180 more attractive end of the fossil fuel
the short term, but the effect of these COMPANIES COMPANIES
investment spectrum, whereas high cost
exclusions over the longer term is less
coal producers are more exposed.
distinct.
Investors seeking financial return
For income investors, the exclusion of Exclusions provider A
will need to be able to sort the best
fossil fuel companies can also have a Exclusions provider B
protected from the most exposed, but
meaningful impact, as dividends from this
Source: Schroders 2017; anonymous data providers individual company responses to the
sectors makes up around 6% of income (2017). All data as at 1 May 2017. *Exclusions for fossil
challenge make shareholder engagement
from the UK market (FTSE All Share fuels based on 10% revenue cut off.
potentially influential. Many investors,
28.02.18). Schroders research shows that
including ourselves, have been vocal in
the tracking error of an income strategy
calling for more robust planning and
increases by over 1% when excluding fossil
Coal generates twice as much carbon greater transparency. Schroders began
fuels based on a 10% of revenue tolerance.
as gas to produce the same amount engaging with companies on their climate
of energy change policies in 2002 and has made
Practicalities of divestment
great progress through both individual
Additionally, not all fossil fuel producers
In order to divest, investors must first engagements, collaboration with other
are the same. Coal generates twice as
determine which companies should be asset owners and participation in industry
much carbon as gas to produce the same
included in the definition of fossil fuel. initiatives. Maintaining our investments
amount of energy, while oil is somewhere
Most choose to do this with help from preserves our seat at the table and
in between. The Church of England
a data provider, who can produce a list enables us to influence change. There are
Ethical Investment Advisory Group have
of companies with involvement in fossil signs that this pressure is paying off. In
determined that tar sands or thermal coal,
fuels. However, different providers have the last few months, for example, Exxon
being the most carbon intensive, are the
differing definitions; Provider A captured has announced that it will publish analysis
biggest concern and opted for divestment
104 companies as having involvement of the impacts of climate change and Shell
from these companies at a 10% of revenue
in fossil fuels, whilst provider B captured has set a goal to halve the carbon intensity
tolerance level. This enables inclusion of
357. The difference in number can mostly of the energy it produces.
companies such as Royal Dutch Shell and
be explained by the wider coverage of
BP, which significantly lowers the impact We have highlighted the range of
provider B. However, the overlap between
on the investable universe. different options available to investors
the two (180 companies) was much
when deciding how to respond to climate
lower than one might expect for similarly
Dialogue and engagement change within their portfolios below.
defined exclusions.
However, perhaps divestment is too Although there may be good reasons
As our ‘Demystifying negative screens’
simple an answer. It is clear that oil, gas for individual charity investors to divest
paper6 highlights, screening is not as
and coal producers will face challenges from fossil fuels, particularly the most
simple as it might seem. Investors need
as demand for their products fade, but carbon-intensive companies, evidence
to determine exact criteria and ensure
the impact on individual companies will suggests that long-term investors can
it matches their individual policy. For
depend on how their businesses adjust to influence corporate practice through
fossil fuel screens, investors will need
the new world. dialogue, helping to steer us towards a
to consider whether to exclude only
lower carbon future.
extractors and producers, or service Coal producers will initially bear the
providers also, and whether to apply brunt of the impact and these, along with
a revenue tolerance and at what level? companies exposed to tar sands, are the
These factors will in turn have different focus for many divestment strategies.
implications on the investable universe. In contrast, gas producers will benefit
DIVESTMENT DIALOGUE
Fossil Full Partial Coal and Coal Engagement
Fuel Free Divestment Divestment Tar Sands only and Active
Ownership
18INVESTMENT THOUGHTS
Charity
Responsible
Multi-Asset Inflation
plus 4%
Fund target return
We were delighted to launch our new
Charity specific investment fund in August
2018 to meet investor demand. The Fund
aims to meet an inflation plus 4% target
over the long term, with a responsible
investment approach. Global equities 70% Property 10% Bonds 10%
Diversifiers 8% Cash 2%
Reasons to invest
1 Charity specific Key features
Investment strategy
investment objective • Charity Authorised Investment Fund –
regulated by the Charity Commission The fund has a long term investment
– inflation protection, and the FCA philosophy – focused on fundamental
analysis & stewardship
attractive income • Strong corporate governance – the
Fund is monitored by an independent • Benefit of Schroders global expertise
2
Advisory Committee for equities and bonds, combined with
Access to Schroders an allocation to third party specialist
• A target return objective of inflation
global investment plus 4% over an economic cycle
managers for alternative exposure
expertise • Responsible investment policy, with
• Fully screened in accordance with
the responsible investment policy;
screening aligned with common charity
3
excluding tobacco, armaments, alcohol,
Award winning concerns and environmental, social
pornography, gambling, coal and tar
and governance analysis, engagement
responsible and voting embedded in the equity
sands, human embryonic cloning and
high interest rate lending.
investment process
investment approach • Integrated equity selection considering
• Income units pay a sustainable
environmental, social and governance
distribution to fund charitable
factors alongside financial analysis
expenditure (targeting 4% p.a. total
For more information please contact
return distribution smoothed over the • Active equity ownership to promote
Jeremy Barker on 020 7658 1107 or
previous three years) positive change
jeremy.barker@cazenovecapital.com
• Liquidity: 12.00 daily dealing • Diversified across asset classes
The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
There is no guarantee that the objective will be met.
19You can also read
