Achi news desk-
The author is president of Queen’s College, Cambridge, and an adviser to Allianz and Gramercy
Early in my investment management career, I was taught to design long-term investment portfolios like a pyramid. A solid base of secular and structural positions, with a much smaller opportunistic and tactical peak. In other words, build a resilient structure that could withstand the volatility of a mostly unstable market and navigate economic and geopolitical upheavals.
Today, this once encouraging construct is seen to be gradually reversed: a shrinking secular and structural base must support a larger opportunistic and tactical top. It is one that, after being extremely durable, is now fueling a debate between those who worry about bubbles and those who are comfortable that structural reinforcements are on the horizon.
Secular investments are emerging over time, powered by a maturation of the underlying return drivers that provides for greater investor adoption. This is the kind of process that is now being demonstrated by artificial intelligence-focused chipmaker Nvidia, which has become the darling of the market. The primary driver is the potential for the large-scale application of innovation in which the company is currently playing a leading role. The turbo charger to its stock price is the shift in its shareholder base from a few highly sophisticated investors to broader buying from the investing public.
Structural investments exploit an investor’s ‘edge’, such as patient capital that can withstand structural instability or misvaluation due to artificial segments in markets. Combined with secular investments, they provide a steady motor that can generate attractive returns over time.
In a perfectly structured and secular investment world, such favorable performance is accompanied by relatively low volatility. At its best, it can be a rewarding version of watching paint dry. Because of this, there is room for investors to comfortably take more volatile short-term positions, as well as react more quickly to opportunistic ones.
Secular investors were helped in the period from the 1980s to the 2000s by three major developments. First, an agreement that domestic economic well-being was best pursued through market-based approaches that emphasized liberalization, deregulation and fiscal responsibility—the so-called “Washington consensus”. Secondly, a commitment to rapid globalization which targeted the process of integrating trade and investment across the border even more closely. Third, the maturing of financial markets including the spread of derivatives, lower entry barriers and the institutionalization of emerging markets as an asset class.
The first two have now reversed course. The shift began after the global financial crisis of 2008 and has accelerated significantly since 2017. Market-based approaches emphasizing liberalisation, deregulation and fiscal responsibility have given way to the return of industrial policy, heavier intervention by government, and persistent levels of fiscal deficits and debt burdens. which was once thought highly improbable. The era of globalization has given way to fragmentation as the combination of geopolitical tensions (especially between China and the US) and a response to worsening domestic inequalities have fueled trade arms and eroded global policy coordination.
The range of structural investments has also narrowed as the dividing lines between investors have narrowed. This can be seen most clearly in the many new vehicles that provide highly liquid access to inherently illiquid investments. The expansion of tactical and opportunistic investments has accompanied this contraction in secular and structural ones. Momentum is now well recognized as a factor that allows investors to ride recognition waves that will break at some point, but not just yet. Such short-term deployment is not just about bottom-up opportunities. It can also be driven by top-down factors, as demonstrated in the past six months by the surge of US stock indices to record levels. The continued economic exceptionalism of the US – including surprisingly high growth rates in the US as Germany, Japan and the UK stagnated – and dovish signals from the Federal Reserve have been important contributors. They have enabled markets to eliminate a host of concerns, whether political or geopolitical.
Unlike the pyramids of Giza, this narrow bottom/wide top construction is unstable. It requires reinforcement from better domestic fundamentals, a less problematic international order, and realizing the promise offered by technology, life sciences and sustainable energy. That is certainly a possibility as currently priced by markets, but it is far from guaranteed.
