2020 has been a year like no other. BlackRock's Sion Cole looks at how the year has changed the investment order – accelerating shifts in how economies and societies operate across a number of different dimensions.
2020 will be remembered as a year like no other as political and economic headwinds grew and pension schemes were forced to grapple with the most volatility witnessed in markets since the financial crisis over a decade ago. Uncertainty ruled, and while some schemes weathered the storm better than others, many have seen their funding levels decrease significantly.
As we start to look ahead to 2021, and hope for a little more calmness and normality, it is difficult to deny the fact that we have entered a new investment order. The Covid-19 pandemic has accelerated profound shifts in how economies and societies operate across four dimensions: sustainability, inequality, geopolitics and the joint macro policy revolution. We believe this calls for a fundamental rethink of investment portfolios - starting now.
First, Covid-19 has put a spotlight on underappreciated environmental, social and governance (ESG) factors such as employee safety, while support for combating climate change has swelled amid extreme weather events.
Second, rising income, wealth and racial inequalities are fuelling dissatisfaction with the status quo and could drive tax increases for the wealthy and higher minimum wages - as well as threats to central bank independence.
Third, Covid has accelerated geopolitical trends such as a bipolar US-China world order and a rewiring of global supply chains. We don't see this as deglobalisation - it is more about the world adapting to this new order. Lastly, the unprecedented cooperation between fiscal and monetary authorities has upended the policy landscape. Indeed, new central bank policy frameworks are likely to keep interest rates low - even in the face of rising inflation. And we are already seeing signs of a risk that central banks become more politicised in the new investment order.
This comes as we expect rising production costs amid a focus on supply chain resilience and greater pricing power of large companies in this environment. Taken together, we believe markets underappreciate inflation risks - and that the coming higher inflation regime will be very different from the reflation debates of the last expansion.
This has significant implications for strategic asset allocations. Key components include a rethink of the role of nominal developed market government bonds, given the implications of the policy revolution: a drop in real yields. That implies - unusually in a more inflationary environment - a favourable backdrop for equities as discount rates are contained by policy. It also means a preference for inflation-protected bonds. We acknowledge these are big calls with much uncertainty - and we will be tracking them closely in the years ahead.
Within the UK pension space we know that every pension scheme has its own set of circumstances and that many of the portfolios from the past won't deliver the results that are needed to deliver for their members in the future. As a result, the needs for many schemes are changing and we believe it is incumbent on us within BlackRock's UK Fiduciary Management Team to work with all of our clients and consider their position to build a tailored solution so they can make the most of this new world order. The result will look different every time; for example, it could include an allocation to a customised alternatives fund for clients concerned with ESG factors, or a tailored cashflow-driven investment portfolio matching specific cashflow requirements.
Going forward, we believe that while we can't remove risk altogether, our approach can help clients to manage it and continue to construct portfolios in line with their own circumstances and requirements. Indeed, in 2019, as political and economic headwinds grew, we reviewed our clients' portfolios and positioned them more defensively, which helped protect them against falls in funding early in 2020. In March we re-risked portfolios, adding to equity allocations for clients, and then locked in profits in April. By late April we had re-risked again, moving between 2% and 8% of portfolios into growth assets, focusing on investment-grade and high-yield credit.
All in all, by the end of September our asset-allocation decision had added an average of 0.6% to funding levels. Outside of the day-to-day of managing of the portfolio, we also worked with our clients to ease the increasing burdens they face, for example from a regulatory perspective helping them with the new statement of investment principles (SIP) requirements set out by the Department for Work and Pensions (DWP).
As the world grapples with the challenge of vaccinating its population against Covid-19 and re-engages with other global issues, from climate change to international tensions, 2021 seems likely to bring more upheaval. And BlackRock's fiduciary management stands ready to help clients weather the storm.
Sion Cole is head of UK fiduciary business at BlackRock
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