WITH the tumult in markets, some sovereign wealth funds (SWFs) or state-owned investment funds are having a tough time to achieve returns from real and financial assets.
There is a risk we have not seen the worst yet, warned Norge Bank Investment Management CEO Nikolai Tangen, as the Norway oil fund, which is the world’s largest SWF, swung into a 14.4% loss or US$174bil (RM818.1bil) in the first half of 2022, both in stocks and bonds, which was unusual.
This year has been a uniquely challenging year, marked by the highest US inflation in 40 years, aggressive US interest-rate hikes, surging energy prices and economic slowdown.
Further tumult is caused by the discrepancy between market expectations of a US rate cut in the second half of 2023 and the US Federal Reserve reiterating that it would keep hiking rates to tame surging inflation.
With inflation remaining stubbornly hot at 8.2% in September, US rates may even reach 4.75% to 5% by early next year, reported Reuters.
This would cause further volatility in financial markets in the near term, said RHB Investment Bank managing director Eliza Ong.
There is a risk that inflation will be tougher to get down than many think, Tangen had warned.
To achieve earnings returns similar to those in the decade following the 2007/2008 global financial crisis will not be as easy.
The golden age of asset price inflation is as good as over, said former Inter-Pacific Securities head of research Pong Teng Siew.
This could be the end to the era of ever lower rates as monetary stimulus gradually loses its positive, short-term bite, and asset prices can no longer look forward to being buoyed ever higher.
The philosophy of “lower for longer” is now likely doomed, and along with that, asset prices in items ranging from collectibles, houses, used cars, bonds and stocks will probably struggle for a long time, said Pong.
Stock markets have experienced one of the worst starts in a year.
The Financial Times Stock Exchange (FTSE) 100 index had declined below the endpoint of the fourth quarter of 2021.
The Standard & Poor’s 500 and Morgan Stanley Capital International rose by only 5% and 1.3%, respectively.
The benchmark FTSE Bursa Malaysia KLCI index has fallen by 7.4% as of beginning of September, 2022, and had seen its value diminished by 10.32% since its peak of 1,618.54 on March 3, 2022.
Central banks have raised interest rates which may not necessarily address inflation woes caused by supply disruptions and soaring commodity prices.
Political rivalry
Intensifying political rivalry between key economies in the West and east as well as political shifts in domestic economies also contribute to tensions globally.
Western central banks are now forced to reckon with the new reality of higher consumer prices; they may have realised that it was not just due to their success in reducing rates that inflation had remained so low for so long.
For too long, the price of consumer goods had been kept low by the rise of China as a manufacturing powerhouse; its sheer productivity had given rise to about two decades of unabated consumerism.
There will not be a next China; neither Vietnam, India or Indonesia can fill the void left by a “slow motion fracture” of global supply chains caused by a Western-led boycott of China due to geopolitical considerations, added Pong.
There are other limits to growth that monetary policy cannot address.
Climate change realities have hit hard in 2022, as drought hit a huge swathe of the Northern Hemisphere, and with that, agricultural production.
Amid plans to rely on new energy vehicles, it should be noted that lithium, used in batteries for all-electric vehicles, is a limited resource worldwide, possibly not lasting beyond 50 years.
Clearer view
Some view that after the next few months, the visibility on central bank movements should be much clearer and this should allow liquidity to stabilise.
Since markets have already factored in a slowdown in the second half of 2022 and into 2023, a gradual recovery in equities is expected, said Etiqa Insurance & Takaful chief strategy officer Chris Eng.
However, global bond yields may rise (causing prices to fall) in the short term, given that yields have fallen too far and too fast.
In the last few years of easy money, new alternative investment classes had attracted a lot of attention.
With the withdrawal of liquidity, blockchain currencies, private equity and other alternatives should see depressed pricing while old economy cash-generating assets – banks, rail roads and retail malls – may see relative improvement in valuation, added Eng.
Due to market volatility, asset owners are changing the way they collaborate with private equity fund managers; they are more directly involved in their private portfolios especially those that are more resilient to recessions, said Ernst & Young PLT partner, assurance, Muhammad Syarizal.
Other SWFs are more experienced in managing alternative investments and may even outperform many private equity funds, added Muhammad.
In Britain and Canada, legislation has encouraged the merger or pooling of local government pension funds that can help build scale.
Even without regulatory changes, a select number of large asset owners have started to position themselves to manage third-party assets such as other non-profit or government entities.
There is also a growing belief in the link between incorporating environmental, social and governance factors into investment decision-making for better risk-adjusted returns.
Net-zero portfolios
Many SWFs are aiming for net-zero portfolios by 2050 or sooner, with key steps that include:
> Defining the climate ambition which requires a holistic strategy that ties together every factor related to an investment portfolio.
> Understanding the portfolio where an inventory of the current portfolio should be created and evaluated against the changes that need to be made.
This includes the current baseline of emissions, a plan for change with pathways for specific sectors, targets for progress and measurement systems.
> Steering the portfolio to deliver results in decarbonisation and generate financial value.
> Ensuring open and transparent communication with key stakeholders and peers.
An endpoint of rate increases may be at around 4.6%, when the US Federal Funds rate reaches “a sufficiently restrictive level,” reported CNBC.
That timeframe for a slowdown or pause in US rate hikes, starting from “early 2023”, will indeed be closely watched.
Yap Leng Kuen is a former StarBiz editor. The views expressed here are the writer’s own.
