Horizon 2021 – Taking on board climate issues in strategic investing, Pictet Wealth Management

Today, Pictet Wealth Management released the 2021 edition of Horizon, its 10-year view on economies, expected returns and strategic asset allocation. For the first time, Horizon analyses the impact of climate issues on economic and financial markets in the years to come.

“As governments and central banks steadily integrate climate-change issues into their policy making, we expect these issues to affect everything from asset-class dynamics to strategic asset allocation and investing styles.” explains Christophe Donay, Head of Asset Allocation and Macro Research at Pictet Wealth Management. “With the covid-19 crisis not fully behind us and its long-term consequences still unknown, the main focus in this year’s Horizon is the rapidly growing importance that climate-related issues will have on economic and financial markets”.

Looking at this edition of Horizon, “Equities are likely to be the asset class most impacted overall,” says Donay, “and we believe that risk assets could involve pitfalls at a time when portfolios’ carbon intensity is coming under increasing scrutiny”.

Covering 50 asset classes in five currencies, this edition of Horizon identifies ten key trends and issues which are expected to shape the future of investing.

  1. Transition towards low-carbon economies will be at the heart of economic and financial-market dynamics over the next 10 years. While our initial analysis suggests that the physical impact of climate change may have relatively limited repercussions on the returns of most asset classes, the transition efforts required under the terms of the 2015 Paris agreement will influence economies and asset classes over the coming 10 years.
  2. Climate change should enhance growth in most places. We see climate change as having a positive impact on the growth trajectory of Europe and, to a lesser extent, China over the next 10 years. For the US, the relative importance of hydrocarbon industries to its economy means the issue is less clear-cut. Depending on the policy decisions taken, climate change could have a negative impact on the US’s prospects in the short term. However, the US has always shown its capacity to surprise on the upside, with the Biden administration already moving fast to address climate concerns in its recovery plans.
  3. Climate change could contribute to a moderate increase in inflation. Adapting economic policies to deal with climate issues could have a positive impact on countries’ growth and boost productivity in such a way that production costs are kept under control and inflation spikes avoided. We have upgraded our inflation expectations accordingly by an average 0.1% per year in China, the US and Europe. Taking into account the inflationary impact of dealing with climate change, we have increased our forecast for the US 10-year Treasury yield from 2.5% to 3% in 10 years’ time.
  4. Cash is not close to regaining its throne. We expect an average nominal return of 1% for US cash over the next 10 years – but a negative real return.
  5. Society will choose discount rates. Through the discount rate, investors evaluate opportunities according to their net present value. We believe it will be societies rather than market mechanisms that fix the discount rate to ensure that long-term climate initiatives are properly funded.
  6. Equity returns will decline. We expect returns from equities to remain enduringly lower than the historical annual average of 9%. Along with Chinese equities, the equities of disruptive innovative companies should continue to offer the most attractive returns.
  7. Illiquidity and private assets present potential for active managers. Private equity should continue to deliver highly attractive returns over the next 10 years in exchange for accepting a large degree of illiquidity. Of the 50 asset classes covered in Horizon, our return expectations are highest for venture capital (10.6% per annum) and private equity (9.4%).
  8. Real assets have a place in strategic asset allocations. The rise in inflationary pressure we expect because of energy-transition policies is a further argument in favour of including real assets in strategic asset allocations as those are among the most effective inflation hedges.
  9. Trends continue to strengthen the case for endowment-style investing. A classic 60/40 portfolio (60% equities, 40% bonds) may be suboptimal at times of higher inflation. From a strategic asset allocation perspective, the multi-asset approach adopted by endowment funds may be more appropriate, as they include a range of real assets that protect against inflation.
  10. Asset allocations should include Chinese assets. Chinese government bonds offer more attractive yields than their developed-market peers, helped by the prospect of renminbi strengthening, while our analysis also shows Chinese equities could offer superior risk-adjusted returns over the next 10 years.

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