Outlook 2021 Perspectives - 10 INVESTMENT THEMES FOR THE YEAR AHEAD
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JANUARY 2021
Outlook 2021
Perspectives
10 I N V E S T M E N T T H E M E S F O R T H E Y E A R A H E A D
INTRODUCTION After a year marked by economic contraction, 2021 stands to be the ‘year of the phoenix’, with a strong rebound in global GDP and corporate earnings in 2021 thanks to the unrolling of vaccines and substantial policy support. Anything connected to the ‘green’ economy will benefit greatly from recovery programmes. Within a generalised recovery, country selection will become important again. Macro hedge funds should do well in this environment. With the US dollar set to fall, emerging-market assets should also perform. We also see 2021 as a year for corporate bond pickers who avoid the extremes between the top and bottom of the ratings scales. But a big rise in indebtedness means ‘who pays the bill’ will be a question investors increasingly ask – with negative implications for government bonds. It will also be worth focusing on the revival of asset classes hit especially hard by the pandemic (what we call ‘loser’s revenge’) – emerging-market equities, small caps and commodities. The global recovery should enable cyclical companies close the performance gap (although persistently low bond yields should continue to help growth stocks too). We also see M&A picking up again, including M&A in mature industries. Increased corporate activity in general will set the stage for event-driven hedge funds to perform. Finally, we believe that some of the investment themes mapped out a year ago have gained extra relevance because of the events of the past year. These include active management, the attraction of real assets, ESG investing and treating volatility as an asset class in its own right. 2 OUTLOOK 2021— PERSPECTIVES
CONTENTS
1. Who will pay the bill? 4
2. The Green Marshall Plan 5
3. Losers’ revenge 6
4. The resurgence of M&A 7
5. Emerging markets are back 8
6. The death of sovereign bonds 9
7. Three convictions in credit 10
8. The bond king is dead. Long live the currency king! 11
9. Positive on real assets 12
10.Play it again, Sam 13
10 INVESTMENT THEMES FOR THE YEAR AHEAD 3
1
W H O W I L L PAY T H E B I L L ?
Within a broad economic recovery, falling market correlation
means country selection will be key
Amid our general optimism about a global recovery, a several critical political events such as the stepping down
number of issues call for careful country differentiation. of Angela Merkel as German chancellor and the push for a
First, indebtedness (household, government, corporate) has second referendum on Scottish independence. The Iranian
grown everywhere – but at different rates. Even more impor- presidential elections in June could be another flashpoint.
tant, not all countries are equal when it comes to their capac- We can already see correlations between countries’ equity
ity to pay the bills incurred by the pandemic. Second, while markets breaking down, a trend that may continue. Falling
the political situation could stabilise broadly in the US and market correlation trends should help macro hedge fund
trade tensions ease (or at least stabilise), next year will see strategies generate alpha.
4 OUTLOOK 2021— PERSPECTIVES
2
THE GREEN MARSHALL PLAN
We are on the cusp of a wave of green infrastructural investment
Cyclical, infrastructure-related companies, particularly ambitions in the areas of energy transformation, sustaina-
those that meet environmental criteria, are set to gain bility and green energy. And the pandemic has put increased
extra impetus in 2021 as governments rebuild their econo- pressure on corporates that have received government help
mies in the wake of the covid crisis. Massive fiscal packages to cut their CO2 emissions. The megatrend toward a more
unveiled by Germany and in Europe as a whole indicate we sustainable and greener global economy is therefore more
are moving towards a modern-day ‘green’ version of the Mar- powerful than ever. We believe that bonds and equities that
shall Plan that helped Europe recover in the years after World have a strong responsible investing component continue
War Two. In the US too, the new Biden administration has big to have strong potential.
10 INVESTMENT THEMES FOR THE YEAR AHEAD 5
3
LOSERS’ REVENGE
The companies worst hit by the virus crisis are poised to make a comeback
In 2021, we expect the unleashing of pent-up demand will and small-cap indexes. But we now believe that innovative
benefit a range of consumer-related and other cyclical small caps that have mastered digitalisation and have op-
sectors that suffered especially hard during the pandem- erational leverage stand to make a comeback. We see equity
ic. Our preference goes to quality companies with balance fund inflows overtaking inflows into bond and money mar-
sheets that have withstood the crisis. However, we will also ket funds for the first time since late 2018. We also believe
continue to invest in tech-related stocks with structural navigating the market’s gyrations and the increase in corpo-
growth advantages. Small caps have had a bad time in recent rate activity (plus a rise in distressed debt) should provide
years, with a big valuation gap opening between large-cap wind to active management’s sails.
6 OUTLOOK 2021— PERSPECTIVES
4
THE RESURGENCE OF M&A
Event-driven hedge funds are set to benefit from a pick-up in deal-making
The extremely low cost of funding and brightening eco- between the decline in the median return on equity (ROE)
nomic outlook are major incentives for M&A. As compa- in recent years and the decline in deal count. Therefore, a
nies and whole sectors respond to a fast-changing corporate post-covid bounce in ROE should be accompanied by a pick-
and economic landscape, deal activity can be either offensive up in M&A activity. Hedge funds that use event-driven
(takeovers by companies that want to expand their opera- strategies can be expected to benefit from corporations’ op-
tions or gain new skills and resources to build market share erational and balance sheet restructuring in 2021, as well as
in growing sectors) or defensive (mergers in mature industries from an increase in distressed issuers.
like European banking). There has been a rough correlation
10 INVESTMENT THEMES FOR THE YEAR AHEAD 7
5
EMERGING MARKETS ARE BACK
Equities and bonds primed to succeed
Emerging markets are set to benefit from a lessening (or at both corporate and government, with yields higher than
least a stabilisation) of trade tensions, a weakening of the US in developed markets for credits of similar quality. While
dollar, a rise in commodity prices and initiatives such as the we have long focused on Asia (especially China) in our EM
Regional Comprehensive Economic Partnership in Asia. This strategy, the broadening of the recovery to other regions
will be good for emerging-market assets, including equities, will be an investment theme in 2021. But careful country
which have been trading at a discount according to several and company selection rather than a broad-brush approach
metrics. We also see opportunities in emerging-market debt, is required when investing in emerging markets.
‘Emerging markets are set to benefit from a lessening
(or at least a stabilisation) of trade tensions, a weakening of the
US dollar, a rise in commodity prices and initiatives such
as the Regional Comprehensive Economic Partnership.’
8 OUTLOOK 2021— PERSPECTIVES
6
T H E D E AT H
OF SOVEREIGN
BONDS
Negative returns ahead
After declining in response to the pan-
demic (and dipping further into neg-
ative territory in the case of German
Bunds), sovereign bond yields have
remained stubbornly low. While we
believe central banks will follow the
Bank of Japan by moving to prevent
an excessive rise in long-term bonds
that would raise government borrow-
ing costs and threaten the economic
recovery, government bond yields will
undoubtedly come under upward
pressure as the recovery takes hold
and inflation expectations rise. The
prospect of negative total returns from
developed-market government bonds
could call into question their tradi-
tional safe-haven role.
‘The prospect of negative total returns from
developed-market government bonds could call into
question their traditional safe-haven role’
10 INVESTMENT THEMES FOR THE YEAR AHEAD 9
7
THREE CONVICTIONS IN CREDIT
Careful credit selection based on fundamentals is of the utmost importance
With credit spreads moving back down closer to pre- bullet credit strategy rather than a barbell approach. Sec-
pandemic levels, 2021 should be a year for bond pickers. We ond, we would rather go down the capital structures of
have three main convictions in this regard. First, our prefer- higher-rated names with strong fundamentals – moving
ence is to avoid both the highest-quality investment-grade into their subordinated debt, for example – rather than com-
credits (yields too low) and the lowest-quality high-yield promise on quality. Third, we believe spread duration can
ones (valuations becoming stretched for the risks involved) still offer yield pick-up in investment-grade credits.
and to focus on a range of BBB and BB-rated bonds in a
‘With credit spreads moving back down closer to pre-pandemic
levels, 2021 should be a year for bond pickers’
10 OUTLOOK 2021— PERSPECTIVES8
THE BOND KING IS DEAD.
LONG LIVE THE CURRENCY KING!
Currencies as an alternative shock absorber to bonds
With prolonged low (or even negative) yields meaning that including the Chinese renminbi, which is supported by
government bonds offer portfolios a very thin cushion, it growth and interest-rate dynamics as well as China’s strong
might be worth considering currencies as an alternative current account. Chinese bonds could be a way to play a
‘shock absorber’ and portfolio diversifier. We expect the US strengthening renminbi. EM currencies in general look
dollar to decline – both because of reduced safe-haven buy- more undervalued than at any time since 2008. But here too,
ing and the disappearance of the yield and growth rate ad- country selection is paramount, with our preference going
vantage it had previously enjoyed. By contrast, we favour a to the currencies of countries with strong current accounts
number of cyclical and emerging-market currencies, and foreign-exchange reserves.
10 INVESTMENT THEMES FOR THE YEAR AHEAD 119
POSITIVE ON REAL ASSETS
Commodities and real estate are worth looking at
Real assets will continue to play a bigger role in portfolio in other areas of commercial real estate, leading to a decline
diversification strategies in 2021. The economic recovery in- in valuations. A reset in this area will offer plentiful oppor-
creases the demand for commodities, including base metals tunities. A weak dollar, the huge liquidity already pumped
and oil. The global decline in interest rates means we also like into the financial system and the prospect of sustained mone-
real estate. While logistical and data centres have cemented tary stimulus into 2021 should support gold in the medium
their place as a theme of choice, covid has provoked a crisis term, despite short-term pullbacks.
12 OUTLOOK 2021— PERSPECTIVES10
P L AY I T A G A I N , S A M
Some of the previous big themes are still alive
We remain attached to real assets and believe that ESG in- standards. There is also the possibility that currency volatil-
vesting remains even more relevant than before. We are ity increases in 2021, with the decline in the US dollar un-
convinced that active management has a role to play in likely to be linear. Moves in volatility in these areas can be
separating the recovery’s winners from its losers, especial- exploited through option markets, for instance. Also, there
ly in a world where we see correlations decreasing. We will are still wide valuation gaps within the equity market – for
also continue to treat volatility as an asset class in its example, between large caps on the S&P 500 and the market
own right. Equity volatility has declined since the peak of average – where we could see big changes.
the pandemic but remains relatively elevated by historical
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