Investment themes such as public policy, geopolitics, demographics and emerging wealth are being overlooked by institutional investors as profitable areas, according to a Watson Wyatt report.
In its recent Macro factors – the update, report, the firm states that these so-called macro-factors themes straddle asset classes and investment managers, and can have a substantial impact on asset returns.
“Early mover advantage is key, as is a thorough understanding of the timeframe in which a macro factor idea evolves as an investment opportunity,” says Tim Hodgson, senior investment consultant in Watson Wyatt’s thinking ahead group. “A few of these macro factors now dominate the investment landscape, mainly as a result of the financial crisis that began with the U.S. sub-prime problems in 2007. While our 2005 outlook was more focused on demographics and emerging wealth, public policy and geopolitics have now become priorities on the investment agenda.”
With regard to public policy, the report notes the difficult balancing act between competing threats of inflation and deflation makes a it difficult to have a central view on the issue. However, it suggests there will be very low inflation in the short term, but with the prospect of significantly higher inflation further out.
Geopolitical trends are important due to their connections with public policy regarding attempts to revive the global economy, says the report. It suggests that protectionism is rife, as governments seek to boost domestic employment levels and protect domestic industries. Watson Wyatt points out the self-defeating nature of such practices as they undercut the effectiveness of policies to boost aggregate demand and restore sustained growth globally.
“Another important geopolitical issue for the future is competition for resources,” says Hodgson. “Most attention is given to energy and materials, but we believe food and water could be surprising sources of conflict in the future.”
There are two methods of accessing exposure to macro factors, explains Watson Wyatt: beta type and option type.
“Beta-type opportunities require constructing an index that reflects the macro factor, or by using existing indices,” says the report. “In option-type implementation strategies, there are two ways to create option style pay offs. The first is by overlaying options added to existing investment portfolios or through embedding optionality created by mechanistic stock or sector level rebalancing strategies. The second is by combining individual stocks and related listed options into a portfolio.”
Hodgson explains that while the macro factors outlook is not clear, steady public policy and measures by central banks are helping to steer the global economy in the right direction.
“Investors with high governance have the opportunity to exploit particular macro factors where they have strong views,” he says. “However, it is worth noting that the main challenge, as ever, is in determining how much of the story is already in the price.”
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