Investment Conference: Rising rates need a savvy response
Investors must accept the days of zero interest rates are over and devise new strategies for unpredictable global markets buffeted by multiple headwinds.
David Coombs, head of multi-asset investments at Rathbones, told delegates at The Scotsman’s Annual Investment Conference that navigating through the investment maelstrom was challenging, but sensible strategies could help savvy investors through.
“We’ve got to learn to live with interest rates being above zero for the next decade,” he said. “That means running money in a very different way.
“I’ve done this for 40 years and seen a few cycles. Gordon Brown talked about the end of boom and bust, but it’s back, so how do we navigate through? I don’t have all the answers, but it’s going to affect fundraising whatever you do – it’s going to be more difficult from here.”
Coombs also said central banks and politicians had made a “complete mess” of the global economy: “US interest rates have gone up really quickly, the fastest in living memory. And we all know there’s a lag between interest rates rises and effects on the economy, right? Everyone does, apart from Jerome Powell [chairman of the US Federal Reserve]. He thinks we’ve just got to keep raising rates to kill inflation.
“They kept doing it until something broke and it’s the 16th biggest bank inAmerica – Silicon Valley Bank… It’s the biggest [financial] experiment ever – and now it’s coming home to roost.”
Coombs went on to say that the European Central Bank decision to increase rates when banks were under pressure was “unbelievable”.
“Things are starting to break. But there’s some good news. If you’re the team sitting around pontificating over increasing interest rates, not much has happened – until now. That might give pause for thought: some banks have gone belly up, is the lag starting to take effect?”
Coombs said he thought inflation would start to fall more quickly, but still feared for the domestic economy: “One reason the UK is more vulnerable is because we’ve got more risk of structural embedded inflation. If the public sector gets inflation-beating pay rises, that puts massive pressure on the private sector and you start to embed inflation.
“It’s a real worry. That’s why I’m under-exposed in the UK at the moment.”
However, he was hopeful the Windsor Framework on Northern Ireland promised better relations with Europe and thought neither Prime Minister Rishi Sunak nor Labour leader Keir Starmer would scare global investors.
Coombs also talked about social media risk, saying it was a “massive catalyst” in Silicon Valley Bank’s collapse. He observed that a group of tech companies communicated with each other online about the challenges facing the SVB and decided collectively to move their money.
“The last big US banks to get a run and go bust took three to four weeks. Now it’s three to four hours. Your brand can be destroyed overnight.
“In any industry where there’s a potentially dubious supply chain or history of product pushback or poor customer service, social media can destroy your business fast.”
He also stressed that traditionally safe havens like bonds were being viewed very differently now: “Bonds aren’t as safe when zero interest rates disappear; they become more volatile. I didn’t invest in bonds for ten years, now I am – they’re more interesting. But they’re not there for safety, but to make money. You’ve got to think about things very differently.”
Coombs said in this environment, his investment team was more active, with trading volumes up significantly. He was targeting companies with very low debt, lots of cash and good profitability, who could “take advantage and gain market share”.
He added: “We’re going to see more companies go belly up, so you want to invest in businesses that can take advantage of that.
“We must be really careful how we allocate our precious capital. I’ve got a lot of cash in my funds at the moment and I’m being very careful before spending. When liquidity is going out of the system, people with cash are king. I’m comfortable because there will be opportunities to use that cash.”
Zehrid Osmani, manager of the Martin Currie Global Portfolio Trust, said they would typically hold only 25-30 sustainable, quality, high-growth companies, identified through fundamental analysis, with 52 per cent of the portfolio invested in the top-ten.
“We harness our very best ideas that come from our research,” he said. “We find these companies through fundamental analysis. So that’s our proprietary research framework with 52 parameters to assess companies.
“This offers an important level of detail, which then permits us to have superior analytics, which means also superior and innovative risk assessments of exposures, and superior portfolio construction.”
The investment strategy is underpinned by megatrends, he explained – demographic changes, future technology, and resource scarcity.
“The megatrends are here to stay and they’re very powerful,” he said. “There are overlapping segments between the three megatrends and that’s where we find areas of particular interest. We’re fairly well diversified across the three megatrends. That helps us manage diversification but also points our research where we might need to do more work.”
He added: “We don’t invest in attractive things. We invest in attractive things attractively priced. We always look for pricing power, and that comes from a strong brand, product innovation, and consumers wanting and willing to spend more for their products.”
Osmani said there was also a focus on strong companies who produce enabling technology, to remove the risk of choosing “winners” in specific fields. This meant investing in companies like Hexagon – “which we see as an industrial technology company with the ability to help other companies with quality checks to avoid interrupting production lines” and to “manage various aspects of workflow and minimise resource usage” as well as improve sustainability.
The trust uses five common factors when assessing companies – climate change, cybersecurity, customer trust, taxation, and finally human capital.
Looking at 2023 and beyond, Osmani said “forecast risk will be elevated and prediction error will be high”, because of the range of variable outcomes around interest rates, wider monetary policy, inflation, and the macroeconomic cycle, before even considering geopolitics.
“We think inflation will remain stronger and longer lasting, although there is scope for it to recede during the second half of 2023,” said Osmani, who also thought the “unexpected and sharp re-opening” of China would be an important driver.
“We believe it could account for 40 per cent of the global GDP growth this year. The momentum in the Chinese economy will to some extent dictate the momentum of the global economy.”
This meant that despite the likelihood of a global recession being avoided, there would be a sharp slowdown and a corporate earnings recession. In that context, Osmani said the Trust would focus on companies that have resilient earnings.
He added: “We want companies with solid balance sheets, strong pricing power – but the most important aspect is valuation. Valuation discipline remains key.”
Project building on Adam Smith’s legacy
The conference heard that the Edinburgh townhouse where Adam Smith spent the last 12 years of his life could become a centre for debate on modern global issues, in the spirit of the man credited as the father of modern economics.
Panmure House, just off the Royal Mile, was where Smith wrote the final editions of The Wealth of Nations and The Theory of Moral Sentiments.
Professor Angus Laing, executive dean of the Edinburgh Business School, said: “It’s very important to recognise that while we laud him as the world’s first economist, he was fundamentally a philosopher. He was a polymath who wrote on linguistics, and jurisprudence; an 18th-Century renaissance man.
“He had a central part in the Edinburgh enlightenment, bringing great thinkers together to go and challenge the ideas of the day.”
Smith lived at Panmure House from 1778-90, but the house had fallen into neglect by 2007 when it was bought by Edinburgh Business School – which is part of Heriot-Watt University – and refurbished over the course of a decade.
Laing said Panmure House was aimed at creating a space for the type of critical, intellectual and sometimes provocative debate fostered by Smith, adding: “To facilitate that debate, we need to be able to make an intellectual contribution ourselves.”
In addition to an annual global innovation prize, and events programme, including a lecture series, Panmure House has just appointed Professor Adam Dixon as what is believed to be the world’s first Chair in Sustainable Capitalism. Two further professorial posts are planned.
Laing thanked the corporate community in Edinburgh and North America for backing the project, and said Panmure House was seeking further support from business and philanthropists to develop its work.
“We’ve got a great range of programmes and we welcome you all to speak to us and explore how you might engage with Adam Smith’s legacy at Panmure House,” he told delegates. “We’re on an exciting journey, and you will hear a lot more as we focus on creating that space for debate.”