2024 Winter Roundtable
INSIGHTS
The PPI Winter Roundtable convened in Napa, CA, on March 6-7, 2024. The roundtable themes of politics, energy, and technology reflected several defining trends. Topics included the investment implications of a record year of elections worldwide, energy transition investments enabled by legislation and climate technologies, the venture capital reset and opportunities in artificial intelligence, and the impact of monetary policy shifts on portfolios and sectors like real estate. The volatile geopolitical environment also weighed on members’ minds as they addressed the risks and opportunities amid rising conflicts in West Asia.
The roundtable followed the second iteration of PPI’s Leadership Lab. Rising asset owner leaders heard from senior PPI members who shared their professional journeys and reflected on industry trends. Lab participants carried this experience into the roundtable.
ELECTIONS AND GEOPOLITICS
In 2024, 74 elections will occur worldwide, with a notable concentration in the economies of the Global South. The U.S. election often receives the most attention, and its successful execution could impact the integrity of democratic processes, including elections, worldwide. Technological advancements, including artificial intelligence (AI), pose a significant risk to elections, as they can exacerbate the dissemination of misinformation.
The world’s most significant election will occur in India, an increasingly important investment destination. The European Parliament elections will be closely watched because they will shape the policy trajectory for one of the world’s largest economies.
Factors such as generational transformation and the level of youth participation, particularly in the U.S., remain uncertain and will be influenced by technological and media change. History underscores the importance of coordinating with allies to ensure the continuity of the democratic process during transformative political and economic shifts.
Claudia Sheinbaum's potential election in Mexico could be a significant milestone, marking the country's first female and Jewish leader. However, continuity in policy positions with her predecessor may mitigate expectations of dramatic policy shifts.
The geopolitical landscape in East Asia is tense, exacerbated by increasing maritime and territorial disputes. While the U.S. military presence reassures allies such as South Korea, Japan, and the Philippines, a delicate balance must be struck to prevent overbearing influence or unnecessary aggravation of geopolitical rivals. Amidst escalating tensions, trade ties are a significant stabilizing force.
Historical precedents offer a blueprint for incrementally renewing collaboration in the complex relationship between the U.S. and China. Returning to Richard Nixon’s and Henry Kissinger’s diplomatic overtures to China, modest economic cooperation laid the groundwork for improved relations. Such historical context provides a roadmap for thawing current tensions.
The hypothetical fall of Ukraine could lead to increased militarization in East Asia, prompting South Korea and Japan to explore nuclear capabilities. Such a scenario underscores the global linkages between seemingly independent regional conflicts.
LEGISLATION-DRIVEN OPPORTUNITIES
While political uncertainty caused by elections in the U.S. and globally dominates the headlines, it’s unlikely the Inflation Reduction Act (IRA) will be rolled back given the political popularity of the spending and that much of the spending is occurring in Republican-controlled districts. Trump has also repeatedly stated that he supports U.S. industry, a position that aligns with keeping the IRA intact. Furthermore, its economic incentives have shown effectiveness in driving investment, especially for sophisticated investors adept at navigating complex regulatory and incentive structures. Meanwhile, the Infrastructure Investment and Jobs Act (IIJA) has successfully boosted public-private cooperation towards achieving climate goals.
In the European Union (EU), policymakers are considering responding to the IRA and IIJA with similar subsidies to enable the region to compete for projects and investor capital. However, despite the political pressure to match U.S. subsidies, they must balance free-market and market competition as critical principles and competitive dynamics within the EU. Australian policymakers view the IRA positively for their industry due to Australia’s exports of essential minerals.
For decades, the U.S. has needed more adequate public sector investment capacity in the infrastructure sector, which has led to infrastructure deterioration. Private sector managers aim to innovate and recycle capital efficiently, and the IIJA should accelerate this. Government-supported policies to scale the industry in the nuclear sector will help reduce costs.
CLIMATE-TECH INVESTING
Despite recent monetary policy tightening in the U.S. and Europe, climate tech investment resilience is evident, with its share of private market equity and grants reaching 11.4 percent in the third quarter of 2023. While early-stage deals have slowed, the influx of new investors into the sector brings optimism.
Key factors sustaining climate-tech investment include supportive government policies, the improving economics of solar and grid solutions, and the integration of AI. Adjacent investment opportunities, such as infrastructure and infrastructure-related services, further expand the sector’s scope and blur the traditional asset class boundaries that typically guide allocators’ investments.
While many view the climate tech opportunity as focused on the energy sector, it is much broader, impacting industries like steel production and supply chains. Sustainable aviation also presents investment opportunities. Technologies like direct air capture and hydrogen technology offer paths to carbon neutrality, albeit with infrastructure and investment challenges. Hydrogen still depends on unproven technology, and building hydrogen infrastructure will require ten or more years and significant capital investment.
Resilient power grids that can manage intermittent power flows from renewable sources are utilities’ investment priority. This investment need is less visible to the public but may be more significant regarding the capital required than energy generation.
CONFLICTS IN WEST ASIA
The geopolitical situation in the Middle East is complex, as many regional and global actors are attempting to secure political and economic advantage from the current turmoil. For several years, the U.S. has tried to pivot its geopolitical focus to East Asia. Support for the Abraham Accords, which has normalized relations between Israel and some Arab countries, has been important for the U.S. However, Increased tension within the area has not only threatened relations between Israel, the UAE, and Saudi Arabia. Still, it has also strained U.S. relations with all three as it attempts to de-escalate the conflict between Hamas and Israel.
The reshuffling of relationships and rising tensions have created an opening for China to play a more active role in the region as it looks to build relationships with Israel, a long-term U.S. ally. Qatar’s global geopolitical prominence has also risen as the tiny Gulf country has leveraged its relationships with the U.S. and Hamas to mediate the conflict. Despite the worsening tensions across the region, an odd point of opportunity has arisen, as policymakers may be able to search for a grand solution that combines a solution to the Israeli-Palestinian conflict with normalized relationships between Israel and Saudi Arabia.
MONETARY POLICY SHIFTS
The U.S. Federal Reserve is shifting its monetary policy stance after nearly two years of raising the federal funds rate to restore price stability. The recent policy meeting signals the Fed’s anticipation of a soft landing and full employment. To support economic expansion, the Fed aims to reduce its policy rate by at least 75 basis points in 2024. Despite a pause in monetary policy adjustments, the Fed remains cautious due to uncertainties surrounding inflationary pressures.
Various factors influence the decision to maintain rates, including sticky prices in specific sectors, such as housing, and potential geopolitical uncertainties impacting energy and food prices. While inflation has eased from its peak, it remains above the Fed’s target, prompting a wait-and-see approach. The Fed’s assessment of favorable economic conditions and risks underscores the need for prudence in monetary policy adjustments.
Expectations suggest a gradual easing of short-term interest rates, likely in the second half of 2024, as inflation recedes and economic growth stabilizes. However, risks on the horizon, such as corporate debt rollovers and the expiration of tax cuts in 2025, pose challenges to the economic outlook. Despite these risks, the Fed’s evaluation implies a rate reduction to safeguard the real economy, albeit after concluding its current policy path.
Such developments amount to a regime shift in the monetary policy environment in the U.S. and potentially in Europe, as signaled by the European Central Bank (ECB) and Bank of England (BOE).
NORTH AMERICAN REAL ESTATE
The North American real estate market remains resilient despite challenges from increasing interest rates and post-Covid demographic and consumer behavior shifts. However, these challenges may reduce overall returns. While rising interest rates may harm valuations, and demographic changes have lessened demand in some sectors and regions, the real estate sector is less distressed than during the global financial crisis. Banks remain well capitalized, and assets generally continue to perform, albeit valuations may decline.
In the office sector, a gap is growing between Class A and Class B assets, with a surplus in Class B assets due to an oversupply of outdated buildings. Increased demolition of the least viable properties may return the market to balance.
A similar dispersion exists within retail assets. Given changing consumer patterns, older malls and shopping centers are no longer viable. However, multi-use developments that match post-Covid patterns of living are performing well. Multi-use developments that blend shopping, office, and living are becoming increasingly common.
Broader demographic and economic shifts are impacting the real estate market across North America. Industrial real estate remains strong following the surge in online shopping and supply chain disruptions. Demographic movement in the U.S. has also impacted multi-family residential development as populations have shifted towards the Sun Belt. However, this regional pivot may be subsiding as geographic mobility slows and as the Inflation Reduction Act and other economic stimulus transform the Rust Belt into a more economically vibrant “Battery Belt” region driven by the electric vehicle industry.
U.S. CORPORATE GOVERNANCE
Corporate governance of publicly listed companies in the United States is evolving. Several factors drive this and increase the accountability of boards to both the public and shareholders. Increased scrutiny of board actions—via media coverage, data on performance, and shareholder engagement—are critical mechanisms for this progression.
Large shareholders are increasingly publicizing their proxy votes in advance to promote investor engagement. While directors are rarely voted off boards, fluctuations in support for directors send an important signal on investor preferences. Activist investors remain a potent force in board accountability. While activists are generally short-term focused, their scrutiny and potential for engaging with a company remain potent influences on corporate behavior.
In response to increased public and investor accountability, board and disclosure practices are improving. Term limits on directors are increasingly being applied, and boards of U.S. publicly listed companies are becoming more diverse. ESG reporting is also improving, though this does not necessarily correlate with increasing focus on long-term financial performance.
Significant challenges remain while investors slowly accumulate more power in corporate governance and board interactions. Executive compensation is becoming increasingly complex, which creates opacity and hinders stakeholders' effective monitoring. Board diversity has improved on some key metrics, such as gender, but less significantly on others, such as age.
VALUE IN ARTIFICIAL INTELLIGENCE
At its core, artificial intelligence is an algorithm that matches inputs to a large set of data. As these algorithms improve, they will become more efficient and require less processing power to operate.
Both private-sector corporations and open-source developers are creating AI models. Open-source development is advancing and is just a little behind the leading private sector efforts. Over time, open-source technologies may become close rivals to private sector offerings. Consequently, it’s not clear that the developers of AI models will profit significantly, given the competition from free options.
Value will undoubtedly accrue to AI users. For example, AI is making coding 10-100 times more efficient and is reducing the costs of all forms of content generation. Over time, the cost of generating online content will fall near zero. AI may threaten the online search and advertising industry as users pivot from Google to using AI to perform tasks. This pivot will impact lead generation and go-to-market planning for many sectors.
Applying AI to investment processes may accrue value to investors. While financial statements contain lagging data covering past corporate performance, AI can analyze large data sets to generate insights on brands, suppliers, consumers, and competitors, better informing investment decisions.
Venture capital is currently experiencing a cyclical downturn in both fundraising and exits. While these cyclical changes pressure venture managers, the global innovation landscape remains robust and continues to evolve. Investment in technologies such as AI is a key factor in VC’s evolution.
For long-term investors with tolerance for illiquidity, such downturns can represent opportunities, as returns in vintage years following peaks in the market are often much higher than average returns.
Investors remain bullish on the long-term VC investment thesis. While many investors aim to preserve diversification across vintages despite cyclicality, others aspire to invest countercyclically and more than their pacing plans suggest during times of market stress.
Increasing globalization of VC and innovation is also changing the industry. While Silicon Valley has been and remains the hub of the ecosystem, many factors are driving the industry to globalize. Talent may be cheaper elsewhere, cloud computing and other technology services are available globally, and building companies closer to consumer bases in other regions may be advantageous. For companies that aim to scale globally, the location of the headquarters may also need to be revised.
A HEALTHY RESET IN VENTURE CAPITAL
One countervailing pressure hindering the industry's globalization is geopolitics, particularly around U.S.-China relations. While the tone is negative, and there is less appetite for dollar-based funding from Chinese innovators, Chinese founders can increasingly turn to the local market.
CEO/CIO PERSPECTIVES
Throughout the session, discussants focused on two key themes: geopolitics and diversity, equity, and inclusion (DEI).
While all recognize the potential impact of geopolitics, there needs to be more consensus about incorporating its effects into investment strategy. How conflict will percolate through industry structures and global value chains is complex. Conflict in the Middle East is a prime example of the complexity: a seemingly regional conflict has impacted global trade flows, and the positions the U.S. and others are taking on the conflict are influenced by geopolitical rivalries with Russia and China. Some investors are also wary of the geopolitical impact of climate change, given the integration of climate risk into areas such as energy and food security.
DEI remains a focus, though it has become increasingly politicized in the U.S. Investors can learn from peers who have incorporated DEI into their business strategies. The challenge is understanding the theme's value, which is less but relatively successful in implementing within complex organizations and in the face of varying stakeholder pressures. Investors cited sponsorship programs for diverse colleagues as especially effective within their organizations. Peer learning on how to navigate stakeholder pressures has also proven critical.
For geopolitics and DEI, speakers noted that understanding how peers approach these issues is crucial. The best practice for each is difficult to codify and depends on organizational structure, governance, objectives, and resources available.
LEADERSHIP LAB
The Leadership Lab explored the role of the chief investment officer (CIO) and how to fulfill the CIO’s duties within a complex, multi-stakeholder investment organization.
Participants noted that the CIO's role is not only an increasingly senior investment one. Rather, the CIO functions as a “sense maker” who guides the organization through the ever-changing investment landscape. Equally significant but less expected duties include leading colleagues in interpreting missions, operating within an imperfect governance structure, forming culture, and managing resource constraints.
The role of setting organizational culture and behavioral expectations is vital. Culture and behavior require hands-on leadership that is bespoke to their organization. The CIO must build a culture that fits the organization’s mission, investment strategy, incentive structure, and stakeholder expectations. The board and close stakeholders, such as plan beneficiaries, are critical allies in setting organizational expectations, and the CIO should forge collaborative relationships with these groups early in their tenure.
Governance of the CIO’s investment organization was also highlighted as a major structural factor that the CIO must navigate. Participants noted that the stakeholder landscape is complex in many investment organizations, especially the public sector, and accountability for executing the fund’s mission does not always rationally or proportionally align with stakeholder interests. CIOs can help shape their governance environment by mapping, educating, and engaging with stakeholders. Speakers noted that the transition to CIO required a pivot in the leaders’ skillset.
All these duties occur in an environment where geopolitics has become a much more material factor. Geopolitics is creeping into the CIO’s role from an investment perspective and increasingly by shaping stakeholder expectations on non-financial requirements, such as investment restrictions.