Range of risks leading even the most conservative asset owners to rethink

Macro uncertainty prompting more active management among public investors

With the global economic turmoil of the last several years now seemingly coming to an end, but the geopolitical landscape developing, global public investors are faced with challenging decisions. Should they move back to bonds or diversify to other assets? Should they take on more risk or wait and see how inflation and interest rates normalise?

According to speakers at OMFIF’s 2024 Global Public Investor seminar, it seems that public asset owners are taking a more active approach to investment management. The event convened senior representatives from central bank reserve managers, public pension funds and sovereign funds alongside private sector experts, who discussed key macroeconomic developments for 2024 and their implications for public investors.

There was a sense of uncertainty regarding the macroeconomic outlook over the next decade among speakers at the seminar. Upside and downside risks abound, as one panellist reflected: ‘No one expected the growth rebound to be strong; no one expected war.’

Accompanying geopolitical risk, digitalisation, decarbonisation and derisking supply chains were cited as three key market catalysts over the coming decade. While the impacts of digitalisation are not yet fully clear, one central banker noted, ‘We are moving day-by-day into a more fragmented world’, which will have negative impacts on trade and productivity. Moreover, the need for a sustainable transition to a decarbonised economy will no doubt be costly as well.

On structural trends, two more ‘D’s were also noted. Demographics threaten euro area gross domestic product growth in the medium term with a 0.5 percentage point drag in the absence of immigration flows, one speaker mentioned, as well as debt, which was acknowledged as a key legacy from the Covid-19 pandemic period.

This plethora of macro challenges is prompting public investors to take an increasingly active approach to their asset allocation. ‘From a reserve manager’s perspective, the horizon for decision-making is far shorter,’ one speaker noted. Asset owners are looking to be more active even among their traditional assets, like sovereign, supranational and agency bonds. ‘The question is how to remain, or how to become, more agile.’

Public debt blurring line between advanced and emerging markets

The prospect of fiscal support in advanced economies was not only seen as a threat to the disinflation process, it was also noted as a key consideration for asset allocation strategies of public investors.

One speaker from an emerging market mentioned that, ‘The teacher is no longer following the textbook’. Many major emerging markets have followed the schema of fiscal consolidation to maintain sound macro fundamentals, while major advanced economies have not. The audience consequently acknowledged, from the public finances front, that there is no longer a clear line between what constitutes an emerging and advanced economy.

This dynamic has implications for currency allocation and government bonds. One public investor noted the term premium on Treasuries is probably too low, while another suggested that rising US debt may be a reason to move away from the dollar. Some panellists pointed out the merits of allocating to renminbi, while others cautioned that, ‘China needs to work on aligning with international practices’ to increase attractiveness to international investors.

Campaign towards diversification continues

When asked whether bonds are back, the panellists agreed that they never really went away. ‘Even during bad times [for bond returns], they are needed for liquidity purposes,’ noted one speaker. At the same time, many public investors mentioned the importance of further diversification – despite relatively high yield on fixed income – to assist with risk management.

This could emerge via equities for reserve managers, as exposure to equities can provide ‘diversification and long-term capital preservation, not just chasing returns’, explained one reserve manager at the seminar. For those who cannot allocate to equities due to their mandate, corporate bonds or money market funds could also offer diversification opportunities.

Some public pension and sovereign fund participants mentioned their focus on alternative assets, such as real estate and private equity, to benefit from illiquidity premium and boost returns. Risks remain on this front – cost, transparency and possible reputational risk of investing in private assets – which could turn sour and are difficult to exit from.

Nikhil Sanghani is Managing Director and Taylor Pearce is Senior Economist, Economic and Monetary Policy Institute, OMFIF.

These topics and more will be explored in OMFIF’s forthcoming Global Public Investor 2024 report.  

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