2021: The CIO’s view - fiscal, ESG and a Biden presidency

I’ll resist the temptation to turn to a thesaurus to find ever more innovative ways to describe just what a bizarre year 2020 was. As we move into 2021 the challenge for us all is to sift through the fall-out to decide what in retrospect will turn out to have been short-term aberrations versus permanent changes in behaviours and attitudes, and the longer-term financial implications of those differences for our clients.

Most market participants agree that the pandemic has accelerated changes that were already underway – perhaps most evident in the move to an online world across the globe. This theme has already been written about extensively. Another area of increased intensity is the global debate on inequality. Post-GFC policy relied entirely on monetary tools – leading to historically low interest rates and plentiful liquidity acting as a huge support to financial assets and, within that, particularly long duration assets (fixed income, Growth equities, high profitability compounders).

There was no commensurate increase in the valuation of real assets and, as Main Street is exposed to the latter whilst Wall Street represents the former, the sense of injustice in a political sense has been building steadily – Brexit, Trump, Salvini. Bolsonaro et al are symptoms not causes. Covid-19 has forced the issue even more; how to protect jobs in the face of a threat that was unforeseeable and no-one’s ‘fault’ – an ‘event’ recession rather than a cyclical or structural recession?

The answer witnessed governments using fiscal policy in tandem with monetary tools - low interest rates funding government spending at levels that were inconceivable 12 months ago. We suspect politics are likely to remain a very real influence on financial markets moving forwards, with Central Bankers acting more as facilitators of policy rather than the main drivers. The long-term ramifications of this are central to the debates we are having across the Investment teams – the crisis itself is undoubtedly deflationary, but the solution may well be inflationary. If so, how long will it take to manifest itself?

Low rates coupled with fiscal spending raises questions as to which assets benefit incrementally. It’s conceptually difficult to be too bearish on long duration assets with rates so repressed. However, given the significant valuation differential between long and short duration after over a decade of extreme monetary policy the sensitivity to marginal moves in inflation and cyclical growth is very high. That provides a potential source of risk for clients if portfolios are tilted solely to the monetary regime ‘winners’. I would encourage you to read the investment team outlooks which go into further detail about where, given this changing landscape, teams are finding relative valuation opportunities and how they are positioning their respective portfolios to benefit from it.

Another area of accelerating change is the profile of ESG within the investment process and the need for product innovation. That Environmental, Social and Governance factors are important in analysing any business is obvious. There is a growing range of data available with various external Ratings services offering their assessment of corporate’s progress in specific areas. The issue we have as investors is that the data itself is often backward-looking, slow to update and – by the nature of being data-centric – leans heavily towards the ‘E’ and the ‘G’ but struggles with the ‘S’. Our excellent ESG team have developed a proprietary ‘ESGIntel’ tool which allows us to access the best data available updated on a timely and iterative basis.

However, a Rating is only one part of the process. The real value-add we offer as long-term, active investors is our level of engagement with companies; we have access to Boards and senior management, and can use our votes and engagement to influence and leverage our views on a wide range of subjects including areas where the data struggles to make a judgement – how does one measure the impact of social media on mental health for example?

In our view, the optimum goal is to work with management teams to make companies better for all stakeholders – financial metrics will always be important but the requirement to achieve these in a way which makes those businesses sustainable in all senses of the word is vital, and as such shareholder and stakeholder values are fully aligned. This is central to the process within all of our funds.

To finish, a change of US President is always significant, but that change coming after one of the most divisive Presidencies in history is of particular interest. The issues that endeared Mr Trump to 70m voters will not go away and domestic and cultural factors will continue to dominate the US agenda.

On a broader basis much has already been said about the likely reduction in US unilateralism albeit geopolitics (particularly with regard to China) are likely to remain complex. Hopes are high for a more cohesive global focus on environmental issues – an area where Europe has some world-leading companies and is likely to export policy and technical expertise. Cohesive action and engagement by other governments will continue to provide growth opportunities in this space. Overall, for risk assets the end of government by Tweet and a return to engagement with multi-lateral institutions should be supportive and help reduce policy uncertainty.

We remain committed to our philosophy of being active, engaged, long-term and valuation driven investors. The world is changing rapidly and requires us to continually challenge historic valuation assumptions but not, we strongly believe, to abandon the discipline of valuation altogether. Our key focus is to assess which assets present the best risk and reward combination for our clients. In an era of extreme policy making, the balance between risk and reward has never been more important.  

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