Many of us can’t think of the fashion, interior design or cars of the 1970s without shuddering. All were awful! However, when we look around at the new world we have just entered, with a conflict on Europe’s eastern front, an oil price near $120 and inflation prints of 7-8% (year-on-year); the 1970s offer some parallels that might provide useful portfolio insights.
We are entering a totally new ball game. The Russian invasion of the Ukraine after 30 years of peaceful co-existence has changed the world map. The huge growth of globalisation that we saw around the turn of the century, with cheap Chinese labour enabling hugely disparate supply chains, is now firmly set to reverse. There was a brief period, during the Covid lockdowns, when we saw similar GDP growth rates in most countries. Two years later, the outcome for different nations and regions is starkly different.
The portfolio structures that have worked so well for the past couple of decades are about to be seriously tested. This is a crucial moment for investors to stress test their investment beliefs and their investment strategies.
Different investor types will have different responses – mature DB Pension Schemes will continue to prioritise risk management and policy adherence, including Taskforce on Climate-related Financial Disclosures (TCFD) climate reporting. DC Schemes will want to ensure their members’ portfolios are inflation-proofed, whilst remaining sensitive to members’ sustainability requirements. Endowments and Foundations will strike varying balances between inflation protection and sustainability goals depending on their missions. Investors may have to make difficult short-term trade-off decisions between their long-term net zero ambitions and short-term solvency.
The current energy crisis highlights the need for exposed countries to establish a firmer base of energy independence. This is one reason the transition to net zero is likely to continue, but the pace of the transition could be impacted as political capital is redirected to address the conflict; through increased defence spending and provision of humanitarian support. In this kind of environment, with energy prices likely to remain highly volatile, investors should be prepared to balance their need for long-term reduction in fossil fuel exposures in order to meet decarbonisation commitments, with short-term return and risk management opportunities that may arise. Decarbonisation at the right price will be an important part of sound portfolio management.
Other portfolio decisions that will need to be revisited will emerge as stress-testing and scenario analysis is carried out against a range of climate and geopolitical scenarios. The emergence of inflation as a key factor, as in the 1970s, will necessitate the repositioning of many portfolios, with fixed income allocations making way for alternative and inflation-protective strategies. The breadth of opportunities within private markets will continue to expand, but liquidity will be as key a consideration as ever.
To return to the 1970s, imagine yourself in 1974 listening to the news on your wireless. President Nixon has just announced a US wide speed limit of 55 mph to save fuel.
Toggle the dial back to 2022, and President Biden is announcing a ban on imported Russian oil. It doesn’t feel so very different!
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