Investment strategy for 2021

Uncertainties (and there are many) make investors nervous. To combat that anxiety, we have a plan and are focusing on three themes: navigating volatility, finding yield and capitalising on opportunities in the mega-trends of digital transformation, healthcare innovation and sustainability. Here’s the plan:

Navigate volatility:

Core fixed income (such as investment grade sovereign and corporate bonds, and high-quality mortgage-backed securities) still plays a critical role in diversifying equity exposure. However, bonds may not be as reliable a diversifier as they once were.

Now, though, we think it's best to add other types of protection to portfolios. We prefer hedge funds as a complement to core fixed income. In 2020, hedge fund portfolios that we manage have performed in line with aggregate bonds, and going forward we expect hedge funds will outperform core fixed income with a lower volatility than high yield. To do this well, we are focused on effective, dynamic managers that operate in niche areas of the market (such as equity special situations, structured credit, merger arbitrage and foreign exchange). Protection is all about managing correlation and diversification; identifying differentiated return streams can help to dampen volatility.

Even within the equity market, certain types of exposure may be less volatile than the market as a whole. Companies with strong balance sheets plus stable growth profiles can help protect capital in volatile markets. So far in 2020, the companies with the best sales growth outperformed by over 20%, while the most leveraged companies underperformed by 7%.

Volatility can also expose value in asset prices. If price declines are caused by developments that are unlikely to disrupt the global healing process, we would likely be willing buyers. Implied equity market volatility is still elevated, which creates opportunities in structured notes and for proven active managers that have the flexibility to quickly reposition portfolios when sell-offs do occur.

Find yield:

Prospects seem bleak for investors seeking income. Interest rates across the global fixed income landscape are at secular lows.

The low yield environment is unlikely to change soon, as it is the global central banks' current policy stance. In the United States, the Federal Reserve has tied future rate hikes to specific outcomes- employment at the maximum level and inflation averaging 2% over time. There is a long way to go until these criteria are met. Expect to see policy rates near zero for years.

Because U.S. Treasury rates reflect investors' expectations regarding future Fed policy moves, the shift in framework argues for lower long-term rates as well. Right now, the market isn't expecting the Fed to raise interest rates until the end of 2023. Meanwhile, in Europe, policy rates have been negative since 2014 and are expected to stay there for the rest of the decade. Yes, decade. Expectations for a rate-hiking cycle from the Bank of Japan are nonexistent.

Yield-seeking investors should face the possibility that the big three global central banks may not raise rates for a very, very long time.

The most obvious solution to this problem is for investors to be very critical of the amount of cash they hold, and consider other means to enhance yield for strategic cash reserves. To enhance yield in core fixed income, we think investors should consider slightly extending duration, and rely on active management in mortgage-backed securities and portions of the investment grade corporate market. Particularly appealing are mortgage-backed securities, given the strong fundamentals of the U.S. housing market and household balance sheets.

Harness megatrends:

Which stocks are most likely to double, triple, quadruple or more in the next few years? We think the best place to look are in these three mega-trends: digital transformation, healthcare innovation and sustainability.

Why these three? Consider this over the last five years, more than 1,700 stocks have contributed to the return of the MSCI World Index. Yet only 42 stocks increased their market capitalisation by more than 4x when they were part of the index. Of those big winners, over 60% came from the technology and healthcare sectors. Moreover, the winners from the other sectors had a decidedly digital aura. Also, those 42 stocks
(2% of the securities) contributed 25% of the index's returns.

Meanwhile, 2020 was a breakout year for investing in sustainability. Just take one look at the performance of clean energy and next gen/electric vehicle stocks: They were up nearly 100% and 33%, respectively.

Digital transformation was the defining market trend of 2020 as businesses, consumers and families learned how to live in an online world. Even so, we are just beginning to see the ways in which technology will influence future production and consumption
(think 5G).

Healthcare innovation- its value and importance was made painfully clear by the global pandemic. But the demand for healthcare innovation is longstanding
and nearly ubiquitous. We see significant investment opportunity in testing and diagnostics, not only for COVID-19, but for many other diseases as well. Even before the pandemic, laboratory testing was the single- highest-volume medical activity in the United States, with an estimated 13 billion tests performed each year.

Sustainability is a powerful trend that will grow in force in the coming years. We expect a big step forward toward developing a more circular economy, especially in the food industry. By 2030, a circular economy could yield up to $4.5 trillion in economic benefits, solving the annual problem of 1.3 billion tons of food waste, 92 million tons of textiles in landfills and 45 trillion gallons of water wasted just through annual food production.

These mega-trends may not only boost portfolios, but can also drive markets for the next several years. These trends are likely to generate superior earnings growth that is not as reliant on cyclical tailwinds. The pandemic is forcing the world to operate in the digital economy. It is also catalysing new ways to diagnose and treat disease. The Biden administration is likely to pursue policies that support the development
of clean technologies and infrastructure. We believe these mega-trends still have room to run.