2019 Winter Roundtable Insights

 

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Introduction

On February 27 – March 1, 2019, the Pacific Pension & Investment Institute (PPI) held its 2019 Winter Roundtable in Westlake Village, California. The discussions centered around the main theme of intensifying global competition for talent. Additionally, delegates discussed immigration policies and their effect on national competitiveness, the serious businesses behind the glamour of the entertainment industry, and why effective talent management strategies are essential to success. In addition, the participants discussed and debated issues related to geopolitics and geo-economics, pensions and the asset management industry, and recent developments in global capital markets.

 
 
 

Key Takeaways

  • Direct engagement on governance issues between institutional investors and portfolio companies can be far more effective than voting proxies.

  • Boosting labor productivity growth is the key to wage increases.

  • The world has a supply-demand imbalance for data scientists, engineers, and other top talent.

  • IPO-sized funding is being replaced by more rounds of venture funding.

  • With only a small handful of exceptions, most brands in entertainment are not global. Companies have to invest aggressively in local content when entering international markets.

  • Brexit is not the only structural issue facing the European Union.

  • Mexican President Andrés Manuel López Obrador’s approval ratings hover between 70 and 86 percent, despite a number of counterproductive policies and crises.

  • Trustee education is important, as most pension plan trustees were not in their current board seats during the last financial crisis in 2008.

  • Investors need to dispel the notion that risk is always much higher in emerging markets than in developed ones.

  • While there may be overlapping engagements with ESG programs, impact investing is distinct in its clearly stated intention, often found in the legal charter of the investment vehicle.

  • In a poll of roundtable participants, 59 percent believed that 2019 would be a risk-on environment, while 41 percent voted for risk-off.

 
 
 

Theme Discussions

Investment Stewardship and Human Capital

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Investment stewardship is a form of direct engagement with the boards and management teams of portfolio companies on governance issues that have material impact or long-term implications for the companies’ financial performance. At its core, it is about protecting the downside. Many believe that this type of engagement is far more effective than voting proxies. In most cases, institutional investors are only minority owners of public companies. Even if the top three institutional investor shareholders of a public company formed a voting syndicate, their shares would still typically fall short of 10 percent. That being said, voting is an important part of the governance toolkit and it should be used in conjunction with engagement efforts. Additionally, some investors are also contributing to public policy debates that focus on the right market regulations to help support long-term value creation.

Where investment stewardship and human capital management most overlap are board composition and employee development. Some believe that the industry acronym “ESG”, which stands for environmental, social, and governance issues, should really be “GS&E,” in that if sound governance practices are in place, the other two considerations are likely to follow. Having a competent and diverse board is not only in and of itself a blessing to the company, it is also uplifting for younger generations of employees, especially when the same level of diversity is embraced when hiring and promoting senior management. As younger generations become more mission-aware or mission-driven, it is important to offer them opportunities for development, rather than straight financial incentives.

Labor Market Trends Beneath Full Employment

Central banks in developed markets have been hoping to see wage increases as they consider further rate hikes and other measures of normalizing their monetary policies. Unfortunately, wage growth has been stagnant almost across the spectrum of post-industrialized economies, including the U.S., where the unemployment rate is at 3.8 percent. If such tight labor market conditions still can’t drive wages up, what can? The answer is perhaps labor productivity growth, which has remained low in the developed world for some time. Inadequate savings and investments, underfunded education and vocational training systems, and to some degree the outsourcing of manufacturing, all contributed to the issue. These aspects are outside of the reach of central banks. In fact, boosting labor productivity growth typically requires the right mix of fiscal policies and regulations (de-regulation in some areas). More investors are becoming involved in public policy advocacy on these issues.

The labor market has also become more polarized in terms of wages. Depending on skillsets and qualifications, compensation can be very generous for certain positions (such as senior management and highly specialized positions) but extremely low for others (for example low-skilled manufacturing and other types of labor-intensive work). The working middle class continues to be squeezed. One example is the reduction of middle- and back-office positions in financial services as those job functions are gradually being replaced by software solutions, often powered by applications of big data and artificial intelligence. The displaced lower-middle-class workers and the low-income working class may become important political voices. Finding ways to improve their livelihood and living standards is an important issue. Guaranteed minimum wages and the gig economy seem to be the current remedies. Some have even put forth a notion that to be a good capitalist, one almost has to be a socialist.

Immigration Policies and National Competitiveness

More and more U.S.-based companies are seriously weighing their options of relocating headquarters or core units to overseas jurisdictions. This is especially true for technology startups looking to relocate research and development departments as nearby as Canada, and as far away as Australia. This is due to the increasingly burdensome process of hiring foreign high-skilled workers. The political pressure to scrutinize and curb H-1B specialty occupation visas and F-1 student visas (in Science, Technology, Engineering, and Math, or STEM fields) comes at a time which many industry executives would describe as a global grab for talent. Salaries for experienced software engineers can easily reach 250,000 USD – 300,000 USD. For the U.S. higher education system, which is competing with Australia, Canada, and the UK as an industry, a steady stream of foreign students is vital from a funding standpoint. In the case of public universities and some private ones too, the tuition collected from foreign students often help subsidize the inadequate funding of undergraduate programs. In the short- to mid-term, the world simply has a supply-demand imbalance for data scientists, engineers and other top talent. Countries with accommodative immigration policies could gain an edge over their technological and economic rivals.

As most post-industrialized economies are at sub-replacement fertility rates, the demand for labor is not confined to the high-skilled category. In fact, all skill levels of labor are needed. Japan, for instance, passed a new immigration bill in 2018 that was aimed at attracting a manageable flow of foreign workers to help replenish the country’s shrinking working age population. But cultural resistance to immigration, sometimes manifested as identity politics, remains prevalent around the world. Historically, anti-immigrant rhetoric and sentiments have been pervasive in societies. Over time, however, people and governments do realize the economic benefits that immigrants bring. It may be politically difficult for some countries to move to merit-based immigration systems. Advocating general openness is more practical. It may take persistent lobbying by, or the relocation of, important companies for politicians to wake up on this issue.

Venture Capital: Peak Silicon Valley?

The decentralization of innovation and entrepreneurship, and the competition from rival tech-hubs are not new to Silicon-Valley startups and venture capitalists. The question is whether this time is different, or whether critical masses are forming outside the Valley. During the last five to six years, 80 percent of the funding rounds of unicorn companies came from emerging markets. This represents a tidal change, as previously the largest tech company initial public offerings (IPOs) were almost all from Silicon Valley. Fifty million active internet users seem to be the magic threshold, in terms of market size, for tech companies or even a tech company ecosystem to survive. Markets like China, India, Indonesia and a few others easily pass that test. Their models are all somewhat reminiscent of Silicon Valley’s. Therefore, the trajectory of Silicon Valley can be used as a reference for investors to gauge where things stand in those markets. Some of Silicon Valley’s own creations have enabled a more distributed tech workforce around the world, further blurring the lines between Silicon Valley and non-Silicon-Valley enterprises. Another headwind for Silicon Valley is the flow of talent. The pace of tech talent flowing into the U.S. is lacking, and there is also an increase in talent outflow. Some feel that in terms of public policy (from immigration to net neutrality) the current U.S. administration has made it more difficult for Silicon Valley to compete globally. Others feel that perhaps the globalization of new company formation, or a democratization of tech entrepreneurship, are positives for the global economy.

The world of venture capital investing is also changing. One hundred million USD funding rounds are now called Series D, when it wasn’t long ago that the same dollar amount represented IPO opportunities. In effect, IPO-sized funding is being replaced by more rounds of venture funding. The advent of Softbank’s Vision Fund further disincentivizes IPOs, not to mention its potential to create dislocations in the industry. For early stage investors, new entrants like the Vision Fund could be seen as a positive. However the industry evolves, it would seem that successful venture capital investors are also those who embrace a long-term investment mindset.

Talent Strategies in the Entertainment Industry

Understanding the entertainment industry, a collection of intensely talent-dependent business models, is an exercise of studying the changes in consumer behavior and consumer demographics in different markets. Contrary to common misconception, the entertainment industry is actually not a global business. With few exceptions, media content is mostly local. Companies like Netflix and Amazon have to invest aggressively in local content by hiring or partnering with local creative talent when they enter new overseas markets.

In the U.S. market, the average American now spends 80 hours a week consuming media—a 16-hour increase from ten years ago. This increase stems from more screens—mobile and tablet devices—and their ability to help viewers multi-task. Families no longer gather in front of their living room TV. Instead, individuals get all sorts of tailored content streamed to multiple personal devices. The viewership problem of some live TV programming, such as American football, is less of a generational problem than it is an attention deficit problem, as younger viewers are distracted by other media content.

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Younger generations also consume just as much news if not more but through very different media formats. These are not in denial of generational shifts in mainstream leisure activities. The average age of baseball viewers, for example, is aging faster than the general population. Video game-based e-sports has become a major new segment among younger generations. E-sports fans tend to spend a staggering amount of time on related content and events, more than any traditional sports and activities. More fundamental demographic trends could also offer long-term business insights. For example, in roughly two generations, one-third of Americans will be Hispanic. To reflect and to address all these transformations, media companies need to have a truly diverse (by age, gender, ethnicity, etc.) and tech-savvy talent pool.

Historically, the entertainment industry has been shaped by big bold bets on new content and new formats that are compatible with people’s lifestyles. In this regard, Netflix is the latest and boldest bet. Its commercial success also confirms that in the age of YouTube and social media, there is still strong consumer demand for professionally produced content and professional quality storytelling. Netflix’s strong performance at the 91st Academy Awards in 2019 will only convince more top talent in the industry, from directors to writers, actors to makeup artists, and everyone in between, that it is now also a serious player on the big screen.

Talent Management Tidbits in Asset Management

Many institutional investors are also updating their talent management practices in response to a variety of developments. Some are restructuring investment teams by sectors or themes, rather than by asset classes, or by developed versus emerging markets. Some are remapping their entire office layout to break down physical barriers to communication and collaboration. Others are being more intentional about promoting inclusiveness and diversity, which often improves creativity and productivity. Still others are broadening their campus recruiting programs to include more majors besides business and finance. Finally, some are focusing on employee development through functional rotation, which also helps keep employees intellectually stimulated.

 
 
 
 

Geopolitics and Geo-economics Update

Uncertain Times in Europe

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As the March 29, 2019 deadline looms, and with the UK Parliament’s resounding rejection of Prime Minister Theresa May’s deal with the European Union (EU), global investors are increasingly anxious about a hard Brexit and the shockwaves of disruption it would bring. Pound sterling exchange rates and sterling-denominated asset prices are already reflecting the unease. Whether there will be a postponement of the deadline or a second referendum, which is an even more unlikely prospect, this level of uncertainty over Britain’s economic future has already led to a sharp decrease in investments in the UK. It is estimated that Brexit-related events since the referendum has already cost the British economy 2.5 percent of lost GDP growth. Longer-term, even if a sensible deal between the UK and the EU is eventually passed, UK-based companies are still likely to go through a tough period, which will be reflected in their earnings growth.

From the perspective of continental Europe, or Europe as a whole, Brexit is not the only structural issue facing the EU. The EU without the UK is essentially just the Euro zone, monetarily governed by the European Central Bank (ECB). The Euro as a currency has been called into question many times, because from a purely economic standpoint, the Euro does not always make sense. However, as a part of a political construct, it is vital to the European Union. These days, there are fewer true Europeans, but many nationalists from various EU member states. Therefore, convergence in Europe is highly unlikely. Identity politics and the rise of populism will likely inhibit Europe from continuing as a unified force on the global stage and in the world economy. Externally, the strategic competition between the U.S. and China is equally likely to test Europe’s unity.

A New Era in Mexico and North America Trade Relations

Like the original North American Free Trade Agreement (NAFTA), the U.S.-Mexico-Canada Agreement (USMCA) is far from the panacea to all trade issues within the trilateral trade bloc. The USMCA will be stronger in areas such as intellectual property protection in digital trade, but much weaker in areas like the investor–state dispute settlement mechanism (ISDS). Another significant part of the agreement is automotive manufacturing, wherein 40 percent of vehicle production has to be assembled at above 16 USD per hour. An over-simplistic, but interesting analogy of the USMCA, is that it is like the Trans-Pacific Partnership (TPP), minus Asia, Australia, and New Zealand.

“Unpredictable” is a useful description of life in Mexico under recently elected President Andrés Manuel López Obrador. Within his first 100 days of taking office, López Obrador swiftly centralized decision and policymaking. Ministers have been stripped of their policy authority. Elites in the Mexican government have fled public office. López Obrador has repeatedly demonized the business community in his speeches. He has also shown a clear preference for Mexican companies over their foreign counterparts. The cancellation of the 13 billion USD airport infrastructure project and suspensions of energy sector auctions sent the Peso plunging past 20 USD/MXN and caused significant unsettlement among international investors. Despite these counter-productive moves, and a number of crises, such as the January gas pipeline explosion in the central Mexican town of Tlahuelilpan, López Obrador’s approval ratings float comfortably between 70 and 86 percent. While it is still early days in this administration, many are skeptical of its ability to put in place the right policies to grow the country’s economy. However, in the long run, investors believe that Mexico still has a few macro and demographic tailwinds behind it.

For more detailed insights on Mexico, please refer to the 2019 Study Mission to Mexico City Report.

 
 
 
 
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Pension and Asset Management Industry Discussions

Long-Term Investment Mandates and Conversations on Risk

There are a variety of legacy issues and real-world structures that keep investors from becoming as long-term-oriented as they aspire to be. Meanwhile, there is a constant struggle between boards and staff on the measurement (in terms of time frames) and communication of risk. Asset owner participants of the roundtable generously shared their practices and pooled their wisdom on these issues. Key insights include:

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  • Some allocators have had really long-term investment mandates with select managers, including ones that have gone on for 13-15 years. The trust that was built through these long-term relationships is invaluable.

  • Some allocators have embraced a “slow to hire and slow to fire” mindset with their external managers, as long as they do not drift away from the strategy for which they were hired.

  • It may be helpful sometimes to remind external managers why they were hired, and also to remind the board and the investment committee why certain managers were hired.

  • Some managers are not meant to be outperforming the benchmarks all the time.

  • Most politicians and trustees do not understand complex performance and volatility metrics, but often tend to act quickly in periods of underperformance. With this in mind, the presentation of performance data needs to be more thoughtful and strategic. For example, quarterly performance may be too volatile and too short-term-focused; consider the use of a cumulative distribution chart, which could show more context.

  • A counter-intuitive but healthy rebalancing mechanism is one that takes money from outperforming managers to add funding to underperforming ones.

  • In conversations about pension plans, there tends to be a fixation on various aspects of investment programs, such as return targets, performance, fees, etc. But few would talk about the bigger issue of unfunded liabilities, which is also a long-term issue. Most funding gaps are not caused by investment programs, nor can they be solved by investing plan assets. Funding gaps are caused by actuarial miscalculations or inadequate contributions from earlier decades, which represent inter-generational unfairness.

  • As a group, investment consultants have sometimes played the role of the guardian of old business practices. Their rigid quarterly performance reporting and analysis is not helpful to fostering the culture of focusing on long-term mandates.

  • Conversations on risk should be had under normal conditions, rather than during a crisis. Decision management tools, such as decision tracking, parameters for review, lock-ups, set-asides, and portfolio rebalancing, can mitigate the downside of common behavioral tendencies.

  • Trustee education is important. Most pension plan trustees were not in their current board seats during the last financial crisis in 2008. Preparing trustees for potential major risk events could help them in their collective ability to make tough decisions under stress.

Curbing Emissions: A New Rulebook and Implications for Global Investors

At the 24th Conference of the Parties to the UN Framework Convention on Climate Change (COP24) in Poland in December 2018, countries adopted a new rulebook for curbing carbon emissions. The rulebook puts into action the landmark Paris Agreement from two years ago by establishing a transparency mechanism with metrics for governments and sub-national organizations. For investors, it provides further clarity on how to manage the financial and technological risks to climate change across a range of sectors, including energy and power. At COP24, global investors also reiterated their endorsement of the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures, which recommends scenario analyses and different disclosures for different sectors.

This new rulebook opens up significant investment opportunities in power and renewables, especially in emerging markets where demand is soaring. Opportunities continue to exist in infrastructure and technology with future growth in areas such as energy storage. Investors also need to dispel the notion that risk is much higher in emerging markets than in developed ones. In fact, the opposite is true in the power sector. For example, the risk is lower in emerging markets because they do not have the oversupply seen in developed markets.

Can Large Institutions Engage in Impact Investing?

An increasing number of individuals and institutions have come to the realization that there are a number of social problems that are beyond the reach of governments and traditional philanthropy. These ills are also being neglected by the private sector due to the weakness of existing business models. Impact investing tackles these problems with a clear and stated intention and aims to deliver market rate returns to investors.

Purveyors of impact investing believe that the asset management industry is at a historic turning point as millennials and Generation Z enter the financial service workforce, bringing with them a much stronger sense of mission. It is a generational shift in values and beliefs. Much like the industry evolved from investing only in stocks and bonds, to strategically allocating to half a dozen major asset classes, impact investing is poised to become a mainstream industry practice within the next decade. While not an asset class per se, impact investing is ultimately about pushing the efficient frontier of investments. There may be some overlapping engagement with ESG programs, but impact investing is distinct in its well-defined impact, or a stated intention beyond financial goals, often found in the legal charter of the vehicle. This intended impact can be any social issue (or a set of social issues) that the fund hopes to address through its investments. For example, one expression of such intent is to promote fair benefits, wages, working conditions and training opportunities for union workers, while trying to unlock values and deliver high-quality risk-adjusted returns in infrastructure investments.

However, not all investors are convinced. Some question the wisdom of identifying one impact over another, which might be of competing interest. Another issue is impact measurement, which always invites debate over accounting and other standards. Finally, and perhaps most importantly for large institutional investors, the mismatch of scale presents a poor case for justifying the time and resource spent on these investments.

 
 
 
 

Market Commentary

Stock Market Volatility and Public Equity Portfolios

The fourth quarter of 2018, especially December, saw one of the worst declines in U.S. stock market history. Listed equity markets in Europe and Asia also suffered sizable losses. Such volatility drove most public equity portfolios into negative territory for the year, which in turn dragged down the performance of entire investment programs for many investors. While most participants in the discussion indicated that they had been expecting higher equity volatility, very few were able to anticipate such intense sell-off towards the end of the year. A possible explanation for the indiscriminate selling of even high-quality company stocks is that some institutional investors unloaded their exchange-traded-fund (ETF) holdings and other passive strategies.

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As for the outlook of the economy, most participants believed that a major slowdown or even a recession could be in store either in 2019 or 2020. Central bank actions, ongoing trade disagreements, Brexit uncertainties, and government dysfunctions were among the main reasons for a neutral to negative outlook. While forward price to earnings (P/E) multiples for both U.S. and world equity are in their mid-teens, a weak macroeconomic environment will limit corporate earnings growth.

Given that stock markets are by and large anticipatory mechanisms, protracted bear markets could finally come after a decade of exuberance. Not everyone will necessarily be unhappy though—active equity managers, for example, may seize this opportunity to prove their abilities to beat passive instruments. But whether the value they add can justify the fees they charge is still to be determined. More and more allocators are now only looking at select active managers who take concentrated risk on a small portfolio of listed equity at long horizons, while most of their public equity portfolios are indexed or put into other passive strategies.

Widening Credit Spreads: Cause for Concern?

Most investors are well aware of the very extended credit cycle in which they operate. However, nobody knows exactly when and in what way this cycle will end. Investors are looking for all kinds of “canaries” for clues. Perhaps the biggest question is how much central banks will pull back on quantitative easing programs and hike interest rates. There are some similarities between the current and previous credit cycles though; for example, like previous times, the yield curve has flattened significantly. As short-term interest rates rise, the net interest margin of banks is being squeezed, which may push some banks to lend more aggressively, in order to maintain their profits. There are also differences that are somewhat unique. For instance, fixed income ETFs were not nearly as prevalent in the last cycle but have since become significant drivers in markets; in some ways, ETFs have taken the place of traditional credit derivatives, such as credit default swaps.

There has been significant build-up in investment grade credit in the past ten years, but less so in the high-yield (below investment grade) category. This may be comforting on face value; however, much of the investment grade issuances have been in the BBB tranche, which is only a notch above high-yield. An economic downturn or slowdown could trigger a wave of downgrades. Because many institutions are only allowed to invest in investment grade fixed income, the downgrades could in turn trigger a sell-off and cause volatility in bond markets. However, this potential development could very well become a buying opportunity for credit, distressed, and hedge fund managers operating in the high-yield space, as some of the potentially downgraded companies may not be as highly levered as others. From a market perspective, these managers may play the role of liquidity providers in those market conditions.

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Credit ratings are of course lagging indicators of credit markets and credit spreads are far timelier. Some investors also use spreads to gauge the relative attractiveness of credit investments, compared to equity. At the time of the discussion, spreads still seem relatively benign, even in markets like Europe and China, where unfolding events and data to be released could trigger spikes. In China’s case, that could mean underperformance of entire emerging market debt portfolios, given the weight of Chinese credit.

Private Equity: Can Out-Performance Continue?

For many investors, private equity was the best performing asset class in 2018. Looking back further, the entire decade following the global financial crisis has been a good environment for private equity in general. However, performances of top and bottom quartile general partners (GPs) differ substantially. In the meantime, the conventional wisdom on return persistence, that funds that have done well in the past are likely to continue to outperform, no longer seems to hold true for buyouts, according to a recent study in 2014 (Harris, Jenkinson, et al., Has Persistence Persisted in Private Equity? Evidence From Buyout and Venture Capital Fund, 2014). GPs that do well tend to be specialists of certain industries or businesses. This is partly a result of intense competition. The buildup of "dry powder" is evident in that there is now far too much capital chasing after a limited number of deals.

Some investors are becoming frustrated with their GPs' slow deployment of capital, while some are no longer content with their role as traditional limited partners (LPs). There is even a growing suspicion among some LPs that GPs hide good deals from them. But GPs might argue that it simply isn't the right time to buy at these lofty valuations. In any case, more LPs than ever now aspire to co-investment or even direct investment opportunities in private markets. However, not every investor is adequately prepared for this aspiration, in terms of staffing and other resources, as deals could become very labor-intensive.

This could be a landmark year in venture capital, as some of the most successful "unicorns," such as Uber, Airbnb, and Slack, are planning their IPOs. However, pre-IPO valuations may become less important in the venture world going forward, as a new class of venture-backed companies dubbed "minotaurs," or those that have raised one billion USD or more in venture funding, have entered the scene. Regardless of the mythical creature metaphors, venture-backed companies are staying private longer.

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Trends in Private Real Estate

Private real estate portfolios have performed well in 2018, perhaps second only to private equity. Many investors have increased their current allocations to this asset class, moving closer to their target allocations. But as the prospect of a slowdown in the global economy looms, investors may be shifting weight within their real estate portfolios, from opportunity and value-added to core. Regardless, a net capital inflow into global real estate markets is expected in 2019.

Real estate investors are investing heavily in multi-family residential properties. Commercial properties, such as office space, are getting less attention, while investors are somewhat divided and polarized in their opinions on retail space. Affordable housing has been a good investment in countries like Singapore, but less so in the U.S. European real estate investors tend to have higher requirements on energy efficiency and overall sustainability of properties, while U.S. investors tend to be more return-driven. However, nowadays it is a competition among real estate developers to build the most efficient and sustainable properties.

The advent of the sharing economy expressed itself in real estate in the forms of Airbnb and WeWork, most notably. The demand for shared space properties is strong and will most likely remain strong in the long run. Even established companies and large banks are now drawn to their flexibility and shorter lease terms. These business models will require constant reconfiguration of interior space to remain competitive.

Global Investment Outlook and Key Assumptions

The U.S. economy is in a relatively good spot with low unemployment, robust consumer spending, a moderate GDP growth rate, and no clear signs of inflation, despite trade tensions with China. Even if inflation picks up, the Federal Reserve (Fed) will have many tools to calm it. The corporate tax cut in 2018 did prop up capital expenditure among U.S. companies briefly, but the “sugar high” began to wear off in the fourth quarter. The longer-term effects of the tax cut are still being studied. Amid all of the above, U.S. companies are likely to see stronger earnings growth than their international peers. On the risk side, investors should adequately take into account political risks in the U.S., especially going into the 2020 presidential election cycle.

Globally, a slowdown in GDP growth could be in store, potentially led by Europe and/or China. Sentiments in early 2018 that aspired to a period of “global synchronized growth” now seem naive and premature. China may have economic weaknesses which are not adequately reflected in official growth rate figures and other data. Some believe that the super cycle of Chinese economic growth over the past 30 years may be over. Few participants believe that trade issues between the U.S. and China will be solved this year. In fact, most believe that the issue is a multi-year, reallocation of global supply chains. But others cautioned not to discount the ability of the Chinese government to quickly change course on its policies and find new ways to grow the world’s second largest economy.

In terms of valuations, companies in developed markets seem stretched and less attractive compared to those in emerging markets. It is hard to argue against the idea that valuations are where they are today because of widespread central bank intervention over the last ten years. In recent years, recoveries from market dislocations seem to have been more “V-shaped” rather than “U-shaped:” for example, after the Brexit referendum in 2016, the U.S. presidential election in 2016, and the December stock market sell-off in 2018. These may be indications that investors have become desensitized to major events, thanks to ultra-accommodative monetary policies.

The effects of slowing, halting or reversing (off-loading) quantitative easing programs around the world, along with interest rate decisions, will remain a key focal point in any discussion about the world economy. Some speculate that at this point in the rate hiking cycle, the world may already be in a slow recession. In any case, central banks need to be prudent in this process, as there are fewer options for them to use monetary policy in order to stave off a crisis or global recession if triggered. It is interesting to interpret from recent statements that the Fed seems to be willing to take into account the reactions of the stock market.

In a poll conducted among roundtable participants, 59 percent believed that 2019 would be a risk-on environment, while 41 percent voted for risk-off. There is variety in the strategies through which investors express these views. Some are strategically tilting more towards illiquid assets and away from developed market listed equity. Many hope to build up their direct and co-investment portfolios, but the competition for deals continue to drive up already rich valuations. Some are beginning to offload parts of their balance sheet that may be cumbersome in a market downturn. Others are focusing more on positive cash flows rather than growth of portfolio companies. Some are cutting back exposure to duration while others are finding ways to allocate to venture capital; some are finding opportunities in private credit; others are not materially underweight or overweight in anything in particular and remain neutral across the board.

 

Scenes from the 2019 Winter Roundtable in Westlake Village, CA