Article | The Global Economy in 2023 and Beyond

Amid a context of unprecedented change and pervasive uncertainty, HSBC global economist James Pomeroy shines a light on the chief drivers of the UK and global economies, identifying risks and highlighting trends to help asset managers make sense of the chaos.

Beset by the gathering clouds of rising mortgage rates and energy price hikes, the UK outlook for 2023 should – by rights – look grim. Instead, to widespread surprise, the economy is showing remarkable resilience. Despite the gravity of the challenges it faces, consumer behaviour remains undimmed. Fuelled by buoyant consumer outlay – spending driven primarily by our post-lockdown need for a weekend away or a good night out – economic indicators have not fallen as precipitously as they might, leaving the UK growth outlook close to zero—flatlined, to be sure, but still some way short of apocalypse.

Chief among the downside risks to this outlook are the challenges facing the UK’s housing sector, where a shortage of homes across the UK – a shortage felt most keenly in the places where housing is needed most – casts a perennial shadow on the property market. A modest decline in property transaction volumes might be expected for 2023, but a more pronounced dip would lead to reduced spending in the consumer sectors that traditionally accompany home buying.

There are mixed and upside risks to the forecast, of course. Full employment and robust wage rates continue to underpin stability in the labour markets, though uncertainties in the macro context undoubtedly remain. Stronger economic resurgence in China, where consumer spending is recovering and property transactions are again on the rise, would bring benefits to many around the world.

Inflation, of course, is the single most influential factor in the mix. It is clear that headline inflation rates are peaking, with food and energy prices expected to soften in the coming months. Core prices have already begun to slacken: shipping rates, for instance, which increased sevenfold during the pandemic, are in sharp reverse. Look beyond the year-on-year rates dominating the headlines and we see that – once rents are stripped out – underlying inflation is quite low. Indeed, a trend towards supply-side disinflation is likely to become more marked and more visible throughout Europe in 2023.

And what of interest rates? Central banks clearly do not want to raise rates any further, but they will be extremely guarded in their approach to cutting rates this year. Supply chains may have eased, but policy committees will want to see a pronounced decline in consumer spending before they allow rates to soften, something unlikely to take place before early 2024.

Article | What Next for Alternatives?

As the fund industry continues its search for profitable growth opportunities in an increasingly challenging market context, a panel of fund managers shared their opinions on current and future trends for alternatives.

• The sustained buoyancy of the secondaries market continues to impress, with transaction volumes doubling to US$100 billion+ from the levels seen five years ago—proof, if it were ever needed, that the sense of stigma once associated with the selling of secondaries stakes has faded at last. With a wide range of trends and indicators pointing upwards – from greater market efficiency to growth in the number of specialist buyers – the market is now widely viewed in a positive light as a valuable source of liquidity. Secondaries, the panel agreed, are here to stay.
• The vaunted “retailisation” of private capital provided fertile grounds for discussion. Some democratisation of private capital seems inevitable, panellists agreed, with strong demand-side interest driven by some retail investors. Banks, too, may welcome the trend as they spot opportunity to differentiate themselves through services aimed at retail customers. Nevertheless, the complexity – and cost – involved in developing entire suites of new retail products suggest that the provider group equipped to take on the challenge may remain small.
• Fears that greater inroads by retail investors could decimate fee structures in private markets are unfounded. In contrast to the ETF markets, panellists felt, a different dynamic is at play with alternatives. New entrants will more likely take the form of high-net worth individuals and private bank clients—sophisticated, well-advised investors. Simpler models might spawn simpler fee structures but a distribution channel will remain and it will need to be remunerated.
• The growth of non-bank lending looks set to continue as banks vacate the lending space and as private funds move to fill the gap. It’s no surprise, say panellists, as market participants on both sides of the equation like much of what they see: expedited turnaround times, opportunities to add scale, significantly lower volatility than in the syndicated loan market—all in addition to the advantage of knowing your counterparty. And with non-bank lending tending to take place towards the top of the capital structure, mega-managers and large-cap borrowers will be increasingly drawn to the private credit space.
• Tax considerations are best addressed early, concludes Dechert and Mergermarket’s 2023 Global Private Equity Outlook report, which highlights the beneficial role that tax-efficient fund structures can play in the alternative space—if properly and promptly addressed.

Article | 5 Key Trends for Institutional Investors

Investors feel the last three years have been exceptionally volatile. The reality, however, is there have been far-reaching changes in macroeconomics and financial markets over the last decade.

Speaking at Funds Congress 2023, Mike O’Brien, non-executive director of Carne Group, said: “Investors have lived through a significant sea change over the last 10 years.”

In 2013, tech was the growth sector, now it is laying off workers; central banks then were a source of stability, and now they are a source of volatility; and inflation has roared back into existence after being long dormant, he added.

1. LDI lessons

In the UK, these issues were further aggravated last year when Liz Truss’ mini-budget caused long-dated gilts to rise rapidly, creating an LDI crisis for defined benefit pension schemes. This interest-rate hedging is used by defined benefit pension schemes to make the valuation of their liabilities less volatile.

O’Brien said: “While the dust has yet to fully settle on the LDI crisis, there is enough perspective to think about the lessons learnt.”

During the crisis, investment consultants and trustees learnt the importance of a governance framework that allowed quick decision making and rapid actions to reduce exposure, protect liquidity and investors.

The LDI crisis was, in a way, a problem 20 years in the making, and the result of regulatory and accounting standards changes designed to correct one issue that created another.

There is, however, a silver lining to the crisis. Pension trustees are now talking about how they think about governance and whether they have the right model – if it should be outsourced or insourced.

2. Remaining innovative

While tech companies can afford to ‘fail fast and learn’, that’s impossible for the asset management industry. The funds industry cannot afford catastrophe when safeguarding investors’ assets and individuals’ wealth. That can slow down innovation.

There are bright spots. The industry is getting better at communicating with its clients to explain why it does what it does. The opening up of private markets is another positive, particularly as it is an important way of channelling capital to sustainable investment.

Fund providers have proven they are agile and adaptable. The industry managed to switch to remote working overnight during the COVID crisis – that would not have been thought possible before the pandemic.

Society’s values are changing with sustainable investment becoming increasingly important to today’s investors. There is growing pressure on the industry to innovate to keep pace with these demands and build trust with consumers.

O’Brien said: “A recent McKinsey report said European products with sustainable credentials on the packaging grew at 28%, while those without these credentials grew at less than 20%.” Consumers are voting with their feet and asset managers need to understand that, he added.

3. Evolution of the active versus passive debate

While the active versus passive debate has rumbled on for many years, it’s becoming more nuanced as the products provided by systematic providers have become more sophisticated.

O’Brien said: “The battle seems to have been won by the index players that are now pushing into thematic products.”

But reports of the death of active managers may well be exaggerated. O’Brien noted: “The average active manager did outperform the index in 2022 – in the precise market conditions you would expect active managers to outperform when there was volatility and low cross stock and intra-sector correlation.”

Nothing can replace the people element of investing. That’s not just asset managers engaging with their clients, but also the conversations those portfolio managers have with companies’ executive boards.

There are times when the research-led approach of active management will pay dividends. Investors need to be judicious about choosing between passive and active. They should also bear in mind that some asset classes can only be implemented actively.

4. The shift to decumulation

Much of the world is grappling with an aging population that is shifting pension savings from accumulation to decumulation. O’Brien said: “A number of years ago, the U.S.’ 401k-defined contribution system went to net outflow for the first time.”

This shift in requirements is a significant challenge for the retirement industry. Adding to this challenge is the change in demographic trends, meaning spending patterns have also changed.

When earlier generations retired, it’s likely their parents would be dead, they would have paid off their mortgage and their children will have left home. Now people might still be paying off their mortgage as they head into retirement, are likely to still have the children at home and could be caring for an elderly relative.

This requires much more complex financial planning that demands a broader product range. It’s likely there will be demand for guaranteed and income products alongside those providing capital appreciation.

But as the pension wealth shifts from defined benefit to defined contribution, this will present challenges for scheme members, as many lack the skills to take these complex financial decisions.

At the moment, however, there is around five times as much money in DB schemes than there is in DC schemes, which means there isn’t the impetus for the change required to ensure DC members can use their pension pots wisely.

5. Diversification into private assets

The most popular asset allocation strategy, the 60:40 portfolio, has performed badly as equities and bonds fell at the same time.

O’Brien said: “The biggest investors protected themselves from these performance challenges  by diversifying into alternative assets. Half of the world’s GDP is now accessed via private markets as the number of constituents in the MSCI world has shrunk by about 20% over the last two decades.”

But it can be difficult for many investors to access these more complex and less liquid markets. One of the big challenges is the time horizon, with a shift to a more short-time horizon for pension schemes that precludes less liquid assets for these institutions.

It would, however, make sense to invest into private markets for DC schemes as the membership is much younger and can take advantage of the longer time horizons of these assets.

That requires a clear regulatory path so asset managers can provide the products that will enable scheme members to benefit from these assets.

In conclusion
While the last decade has been a period of change both in macroeconomics and financial markets, further transformation should be expected in the next 10 years.

Asset managers will need to adapt to changing consumer demands, increased interest in sustainability as well as the need to maintain trust in the face of greenwashing concerns.

Changes in demographics and a shift towards defined contribution schemes will also challenge the industry to broaden asset allocation and develop products that match the greater complexity facing those retiring in coming decades.

Article | Meeting Today's Asset Management Demands: Five Asset Management Trends Driving Long-Term Growth

The last three years have been a period of profound and rapid change. The funds industry has dealt with the Covid crisis, a remote working revolution, the war in Ukraine, cost inflation, volatile financial markets and UK political instability.

Speaking at the 2023 Funds Congress, John Donohoe, founder and Group CEO of Carne Group, said: “It is a much tougher environment for many businesses than it was only a few years ago.”

But there are reasons to be optimistic. Donohoe adds: “The fund industry will continue to expand as it takes business from more traditional players like banks.”

Carol Widger, Partner at Dechert, added: “At this conference three years ago, there was one ESG panel but this is now a topic which permeates the industry and is one of the key issues on the regulatory agenda.”

Speaking at the same conference, Steven Libby, Asset and Wealth Management EMEA Leader and Partner at PwC, said: “The industry has adapted rapidly with sustainable investment funds now representing 46% of products in 2022.”

To ensure companies can thrive in today’s much tougher environment, business models need to be sustainable. There are five key trends which the industry needs to address to drive long-term growth in the asset management industry.

1. Maintaining trust in sustainable investment

Despite the recent success of sustainable investing, it is a nascent industry with many issues to be resolved.

Speaking at Funds Congress, Karen Zachary, CEO of Crux Asset Management, said: “It’s difficult for boutique managers to embrace this development if they don’t have the resources to hire an ESG team.”

In addition, Inadequate data makes running sustainable investment strategies more complex as it makes it harder to benchmark funds and compare companies globally.

There is a danger that the opacity and lack of clear standards makes the end-investor think fund managers are greenwashing.

According to Morningstar data, some 40% of funds were shifted by asset managers from Article 9 to Article 8 categorisation in the final three months of 2022. This will erode consumer confidence in sustainable investment products.

It’s important the fund manager is clear about their intent, then explains the process to align with that intent and looks at outcomes relative to the intent and the process.

But it is difficult to demonstrate the outcome given the data challenges. David Rae, Head of Strategic Client Solutions at Russell Investments said: “There is, however, a lot of evidence solutions are being developed to overcome these issues.”

2. Coping with regulatory complexity

In a poll taken at the 2023 Funds Congress, the audience ranked new ESG regulations as their primary regulatory worry divergence between the UK and EU rules as a close second.

There is an increasing disconnect between the different approaches taken by regulators to sustainable investment. This can make it very complex for a funds business to align its products for different jurisdictions.

In particular, the Financial Conduct Authority (FCA) is approaching its Sustainability Disclosures Requirements (SDR) as a way to label funds which is different to the approach taken by the EU.

SFDR was conceived as a transparency framework in order to foster common disclosure practice but is quite often taken as a proxy label for a fund.

ESMA recognises, however, there needs to be additional minimum sustainability criteria particularly for Article 8 funds, which are seen as problematic because there is lack of guidance and common understanding.

Broad labels for sustainability finance as proposed by the FCA will help to provide more clarity for retail investors.

3. Reacting to demographic trends

Demographics presents both a challenge and an opportunity for the funds industry. An ageing population will become evermore reliant on savings products as they retire. But the industry also needs to consider how it will market its products to younger consumers.

Gen Z are 25% of the population and are expected to be the world’s highest spending cohort over the next decade. The industry needs to engage with this group in a different way. Trust is particularly important for this group who want companies to live their values.

James Pomeroy, Global Economist at HSBC Bank, agreed: “The values of people in their twenties are wildly different to earlier populations.”

Around half of this cohort are influenced by TikTok yet no-one in the fund industry is using this platform to engage with this population. The finance industry will need to embrace this change if we want to sell to these younger groups.

The impact of slowing growth rates is another factor the funds industry needs to consider.: “Shrinking working age populations are going to be a reality in Europe this decade, added Pomeroy.

4. Improving the customer experience

At Funds Congress 2023, Donohoe said: “Businesses need to be simplified so they can be nimble. Those who are first to market get the biggest slice of revenue.” Building the right infrastructure is the key to ensuring fund providers can act swiftly.

Andy O’Callaghan, Global Advisory Leader of Asset and Wealth Management at PwC, added: “Technology is a vital part of the entire ecosystem from the management of investment products, the operational infrastructure needed for custodian and fund administration as well as the distribution to clients.”

But even though technology is so important, the industry has been slow to adopt new methods. The shift towards auto-enrolment has created millions of new customers which will create a challenge of scale for the industry.

The industry needs to start matching the standards delivered by other service sectors. If investing isn’t a seamless experience, then it will be difficult to get customers to save and invest over the long term. The first step is getting rid of the more antiquated processes.

5. Managing geopolitical risk

After decades of smooth sailing, geopolitical risk has come roaring back. Lord Gavin Barwell, Senior Advisor at PwC, said: “We left the bipolar world of the cold war behind us and are now in a multipolar world.”

A key reason for this is the US’ reluctance to play global policeman. This multipolar world is accompanied by a retreat of liberal democracies which has been driven by social media and dissatisfaction, added Barwell.

Climate change will mean there will be mass migration of people which can create political instability. Barwell said: “Control of water resources will become as important as oil was in recent decades.”

As the world transitions to the green economy, there will be a competition for the minerals vital for this revolution. After 200 years of a more globalisation, we can expect this to retreat somewhat as trust breaks down between countries, added Barwell.

Navigating these trends

Given the depth and complexity of these five trends, it’s understandable for executive boards to feel overwhelmed. But the volatility of the past few years has shown the dangers of inertia.

The world has become very complex which makes it impossible to view the whole system and see all the causes or possible outcomes. Maximising the strength of your organisation requires a diverse workforce who have their views heard.

Close collaboration will be required to ensure companies can maintain trust in the sustainable investment process as well as ensuring the firm can stay ahead of regulatory complexity.

But strong teams are not enough. In an ambiguous environment, scenario planning is a necessity. While demographic trends are often predictable and allow a company to prepare for the future, geopolitical risk is much more uncertain and it is important that firms think about the impact this could have on their business.

Ensuring customers have a good experience which is constantly improving requires a company to look carefully at what they do well as well as what they do badly to drive innovation.

Companies need to be prepared. That means thinking about what we should do now for the scenarios which would be most harmful to the business.