EXPERTISE - NNIP

Times of trouble

11 Septembre 2017 Par Valentijn van Nieuwenhuijzen
 (Photo: NN Investment Partners)

Investors are currently realizing that the levels at which markets trade make it more challenging to deliver attractive investment returns than in recent decades. Cash and savings rates remain extremely low and bond and equity prices have moved up so much that the potential for additional gains is being questioned by many. Also, and not for the first time in the last few years, markets are struggling to find the balance between economic fundamentals, the outlook for policymaking and (geo-)political risks.

Obviously, the intensification of the Korean crisis in recent weeks is the most eye-catching component of the investor puzzle at this point, but certainly not the only one. The effort to put all the pieces together is clearly creating some headaches for money managers and the mood amongst investors has been coming down as a result of that recently.
In these times of trouble, a couple of observations can be made that help to create an anchor of thinking. The first point that remains important to not overlook is that the macroeconomic reality has rebased that whole market environment over the last decade. The aftermath of the financial crisis and the following Great Recession created the unusual landscape of disappointing economic recoveries and continuous down-drift in global inflation. In this environment the behaviour of people and institutions also adapted.
The following evolution of the market ecology created a reality of close-to-zero return expectations for cash and savings account holdings. Partially because the gravity of zero cash rates drove down the level of interest rates across the world and on all parts of the yield curve in most bond markets. And given that everything is interdependent this also drove investor flow towards risky assets and created price adjustments in credits, equities and real estate assets. These asset classes might still offer reasonable or even attractive risk premia compared to a government bond alternative, but that only creates the opportunity to generate excess returns over bonds. It does not take away the uncomfortable fact that absolute returns of a diversified investment portfolio will be lower over the next 3-5 years than what was seen over the last 3 to 4 decades.

As a result the need for different return drivers for investors has increased. The uncertainty related to this new environment has actually also created opportunities. The new market ecology also behaves in a different way. Those investors that understand well that they also have to adapt can exploit these opportunities. This can be done by becoming more flexible and more willing to actively play the shifts in risk premia between the different asset classes, regions and sectors. Both the absolute returns of multi asset portfolios and their robustness can be enhanced that way. To be effective with this approach, the traditional approach to analyse underlying economic fundamentals is not enough. More than ever the forces that drive the current market ecology cause markets to deviate from the assumption that they trade “efficiently” on the back of underlying fundamental information.

However, if you are successful in profiling the emotional drivers of market behaviour and combine this with the fundamental trends then the benefits of an adaptive investment approach can be exploited. With an ever-increasing new set of information sources and techniques through the fascinating innovation in digital communication, Big Data and machine learning there is ample opportunity to do this for those investors (like NNIP) who are willing to explore this in a rigorous way.

But even when these digitalized ways of investment analysis are fully utilized it will never take away to need to add the indispensable human component to the overall assessment of return opportunities. Just like “freestyle” chess players - which consist of teams of amateur chess players and standard chess computers – are still able to beat the best stand-alone chess computers in the World, human investors that are augmented by top technology remain best suited to survive in the current market environment.

It needs to be added however that this will only hold if they also work with a rigorous decision-making process. Whether it is the assessment of tomorrow’s ECB meeting, the fallout from environmental shocks (like Hurricane Harvey or Irma) or geo-political tension surrounding North Korea it remains crucial to use team experiences, open-minded thinking and outside-in perspectives to enhance the more data-driven insights on markets. This is needed because data and the historical patterns they capture are never able to correctly fully capture the uncertainty of the future. They will always struggle to predict the non-linear adjustments that happen in complex systems like economies, societies and financial markets. This is where human imagination and creativity are actually better suited to understand the balance of risks and the opportunities surrounding rare or even unique shocks to the system.

And still, with all this in place it will not be easy to overcome all challenges that investors face today. It will, however, help to keep our heads cool, stay focussed and to make consisted decisions. In time of trouble that is worth a lot.

http://paperjam.lu/expertises/investment-view

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