We expect that 2019 will bring a trilogy of challenges to North America. In particular:
Here is an overview of our Outlook. Download the report to read more.
Key actions from a macro viewpoint also make sense through other portfolio construction lenses
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At Willis Towers Watson, we believe no single approach to portfolio construction can yield “the answer.” Therefore, we consider the problem through multiple "lenses," four of which are displayed below. Doing so shows that ideas make sense based on our macro views will tend to make sense anyway.
We think the chances of nasty surprises has gn. How can we deliver needed returns but in a way that reduces the risk of unexpected events?
Why? Diversification is always a good idea and is an especially good idea now. However, the perception, and often the reality, of doing so is costly, time consuming and complicated.
How? Diversification doesn't (always) have to be burdensome. Ideas which are consistent with our macro outlook are below.
Most North American pension plans could benefit from reducing exposure to equities outright. Simple ways of selling equities while not sacrificing too much return include investing in:
Finally, while diversity doesn’t always have to be complicated, sometimes complexity is the price to pay for attractive assets. The governance required to cope can be acquired through delegation.
Why? Because risk should only be taken if it is rewarded. From a corporate perspective, reducing risk means improving certainty while maintaining return – a win-win. However, once again, the perception and often the reality of doing so is costly, time consuming and complicated.
How? Again, reducing risk doesn't have to be burdensome. We encourage DB investors to think about their approach to Liability Driven Investing (LDI). In particular:
We also encourage investors to integrate scenario analysis into risk management. Investigating specific macro risks – such as the possibility of a Japan-style deflationary equilibrium – and what to do about them makes sense if we are close to an economic inflection point. The impact of key disruptive megatrends, such as demographics, technology or environmental risks, can also be assessed this way.
Why? Understanding the range of outcomes is an important way to reduce uncertainty. That understanding can be used to dynamically manage risk or to create value. There is no disguising it: creating value through dynamism is a complicated, time- and resource-intensive process and should only be undertaken by those with rich governance budgets and appropriate beliefs. Whereas using dynamism to manage risk is more widely accessible.
How? Dynamic risk management in practice means implementing a journey plan. Where are you going and how you will get there? Surprisingly few plans have solid answers to these questions and, as a consequence, are likely running a sub-optimal strategy. This is more relevant now because funded ratios will have improved significantly over the past few years and our outlook suggests now might be an attractive time to de-risk.
Ideas to dynamically create value, which we consider for the portfolios we manage include:
Why? The reality investors face is, in our view, one of generally low returns – due to low cash rates and starting risk premia – and elevated volatility as the business and capital cycles move through their late phases. In this environment, the value of genuinely skilled active management is outsized.
How? Again, we will not pretend finding skilled managers is easy. However, it is possible, as demonstrated by our track records. With alpha in your toolkit you can consider the following:
Why? The world economy can increasingly be simplified to three centers of gravity:
These centers of gravity operate in economic terms (quantified above), political terms and, more recently, investment terms. Until now, locally-listed Chinese assets have been hard for foreign investors to access. But China’s gradual financial liberalization means this is no longer true. This third opportunity set is now open to North American institutional investors and, in our view, cannot be ignored.
How? From an opportunity set perspective, it makes sense to access this large and ging set of cashflows. But, the attraction of China’s markets is not about stellar returns but stellar diversity. Because its economy and capital markets are still relatively closed, its economy and its assets will operate on a different (albeit not entirely decoupled) cycle to the rest of the developed world economies and capital markets. Assets that behave differently mean diversity – this makes China's local capital markets attractive to investors.
However, capturing that diversity is not that straightforward:
Therefore, we want exposure to both risky assets, (e.g., equities and private markets) and bonds. These assets also need some form of cost-effective active or smart beta management. This is possible to create separately, but is time-consuming and resource-intensive. Cost-effective “one stop shops” combining well-structured equity portfolios plus bond exposure are rare but available. Investors will need to be somewhat brave and innovative to capture the early diversification benefits on offer.
The contents of this article are for general interest. No action should be taken on the basis of this article without seeking specific advice.
| Title | File Type | File Size |
|---|---|---|
| Five year capital market outlook 2019 - North America | 12.9 MB |
David is the Global Head of Asset Research at WTW, responsible for economic and capital market research. He also is a member of the Investment Assumptions Committee, who help guide investment policy globally.
Mark is a Senior Director in the Insurance Consulting and Technology business. He has over 15 years of experience working with U.S. domestic and international insurers on topics that include capital modeling, risk management, financial modeling and reporting, and M&A.
