Mid-year webcast: Curating portfolios for megatrends and inflation risk

The global recovery BNP Paribas predicted at the beginning of the year remains on track, according to Prashant Bhayani, Chief Investment Officer, APAC, even though the emergence of the Delta strain of the coronavirus and the varying pace of vaccinations have made the recovery slower and more uneven than expected.

“Despite this differentiated recovery scenario, 2021 investment returns to date have fulfilled our forecasts,” said Bhayani. “Equities and commodities have produced strong returns, with cyclical sectors rising most, while the ongoing low interest-rate environment has stilted fixed income’s performance.” He looked at global services sectors to illustrate that emerging markets are lagging behind the US, EU, and UK, which are enjoying a vaccine-driven boost as lockdowns are relaxed.

“Based on the current pace of vaccination-driven recovery, we see growth continuing above trend into 2022,” Bhayani said. “The strong correlation between government stimulus-driven liquidity and market returns will likely continue.” BNP Paribas predicts the US economy will expand by 6.9% this year and maintain a healthy 4.7% growth rate next year.

Inflation: transitory or long-term?

One factor has gained more prominence than anticipated in January: inflation. Bhayani explained: “While it has become clearer that inflationary pressures are having an effect on recovering economies, the question remains: will it be transitory or a longer-term phenomenon?” An analysis of US Treasury 5-year forwards predicts that long-term inflation will remain restrained, averaging over 2% for some time.

This suggests that there will be no ‘taper tantrum’ prompted by the US Federal Reserve reducing its liquidity support measures. “The Fed has indicated that employment figures will be a decisive factor in both raising rates and tapering quantitative easing measures,” said Bhayani.  “As jobless numbers remain below pre-covid levels, we see a cautious, controlled taper in 2022 with rate rises to follow only in 2023.”

But risk-averse investors may still be concerned that transitory inflation could dent their returns. “This risk can by managed by remaining overweight on assets that are highly correlated with inflation expectations,” said Bhayani. “That includes cyclical sectors in the EU and UK like materials, financials, industrials and energy. If investors are concerned about consistently rising inflation over a longer-term period, commodities and real estate added to the portfolio will contribute 16% and 9% per year, respectively.”

Equities remain the preferred asset class: “Yields are still attractive, while bonds, credit and cash will return less than inflation,” explained Bhayani. “Even though equities have risen 31% since the beginning of last year’s fourth quarter, history suggests that a good first-half performance is a strong indicator of a good second half.”

Themes for the future

Bhayani’s investment themes for the second half and beyond aim to build exposure to “investment megatrends” that will dominate the years to come, while combining equities with alternative assets to produce real returns with a lower risk profile. 

“Global healthcare, food & beverages, and technology promise returns over the long term, while income can be boosted with selective exposure to Asian and global high-yield bonds,” said Bhayani. “Emerging markets’ US dollar bonds, followed by those in local currencies, Asia-pacific high-dividend equities, COCO bonds, and private real estate all have the potential to provide extra growth within portfolios.”

The remaining themes revolve around the ongoing recovery from the pandemic and the challenges of climate change. The three biggest economic blocs – the EU, US, and China – are now united on net zero emissions targets, providing powerful impetus for businesses engaged in the global drive toward a carbon-neutral future.  

“We strongly suggest looking at carbon credits,” said Bhayani. “As decarbonisation initiatives increase in scale and urgency, the requirement to transfer risk through pricing and trading carbon will drive strong growth.” He pointed out that the EU carbon credit price has doubled since November 2020, and according to the BNPP Low Carbon 100 Europe index, the shares of companies with low carbon footprints consistently outperform.

In a related theme, the bank sees the future of global food and water efficiency and security as a significant growth area. “For example, producing meat creates carbon emissions and is energy intensive,” said Bhayani. “Sectors associated with food efficiency and scientific agriculture will grow faster than the economy – and this will be a megatrend that will continue long into the future.”

Coming back to the global pandemic recovery, Bhayani outlined the year’s final theme: a ‘consumption tsunami’ driven by pent-up demand – or ‘revenge’ spending. “Data shows that the savings rate went up following the start of the pandemic as consumers shelved spending plans due to lockdowns and prolonged uncertainty,” said Bhayani. “This year, retail sales have skyrocketed in line with reopening in major economies; in addition, real estate is recovering.” He added: “With rents rising as well, real estate offers both capital appreciation and a steady income.”

Guest views

This theme received further support from guest speaker AJ Agarwal, Senior Managing Director in the Real Estate Group at Blackstone Group Inc, speaking from New York. “We are focusing on asset classes and markets which can benefit from long-term trends that grow faster than inflation,” he said. “These include warehouses and data storage assets that are in demand due to 20% annual ecommerce growth, as well as studio space which benefits from increasing content creation for digital platforms.” 

Ivan Massonnat, a partner at venture capital firm PAI Partners and an experienced winemaker, concluded the mid-year update with an introduction to the innovative biodynamic approach used at his Domaine Belargus estate in France’s Loire region.

“We keep grass and natural herbs between the vines as the basis of a chain which includes birds, worms, and animals in a living environment which encourages the vines to adapt to their plot,” he explained. “This is an ecosystem and the vine is a part of it.”

Massonnat also underlined the risks posed by climate change. “It’s getting warmer earlier, making the plants vulnerable to spring frosts – you can lose 80% of the harvest in one night,” he explained. “There’s not much you can do: our solution is a longer ageing process so we always have stocks in reserve for a down year.”

This careful curation results in unique and complex wines which have been critically acclaimed, and offers an enlightening metaphor for investors looking to position their portfolios for the years ahead.