Where this US$1 trillion manager is allocating funds over the next decade

A new capital market assumptions (CMA) paper from Northern Trust Asset Management suggests the higher for longer interest rate environment may not necessary lead to a more difficult environment for assets.

The 6 themes and their impact on its asset allocation decisions were explained n a webinar on 4 October 2023 by Wouter Sturkenboom, Chief Investment Strategist, EMEA and APAC, and Chris Shipley, Chief Investment Strategist for North America. 

And although it has a Eurocentric and North American view, they do take a look at markets more globally, including Australia. 

In this wire, I look at the six key themes (the strategic outlook) from Northern Trust before examining the firm's tactical outlook (12 months). As with all presentations, they caution that past performance is not indicative of future performance. You should also be aware that their forecasts rest on a number of assumptions that are presented in more detail in the full paper. 

In the past, these CMAs have taken a five-year time horizon. But this one is 10 years, and Sturkenboom explained why this change was made in the webinar:

"Frankly, our investment audience came back to us and said 'well, five years is great.  It gives us a good sense of where the business cycle is evolving towards. But 10 years would be better because it better aligns with our investment strategy outlook'." he said, adding there was an advantage in a longer term for the investment teams, "You can let go of the business cycle and focus more on the structural trends." 

Growth restraints 

Looking at seven different economies on a national or regional basis, Northern Trust analysts conclude that GDP has not been growing at the rate that we've become accustomed to. This is reflected in their lower 10-year forecasts across several major economies and regions. 

Inflation adaptation 

The analysis also indicates that the world has to adapt to a new period of higher inflation, with the chart below indicating their 10-year forecast for annualised inflation varies across these different economies. Some like the US and Canada are forecast to have the same levels, while they forecast higher annualised inflation for Europe, Japan, the UK and Australia. 

Central bank concessions

Central bankers may be less interested to lower interest rates, recalling that the historic 10-year policy rate includes the tail end of the GFC and periods of negative rates in some economies. The chart below indicates Northern Trust's view that central bank policy rates will climb over the next 10 years before reaching their terminal forecast rate. 

Geopolitical fault lines 

Sturkenboom argues we are currently witnessing the de-globalisation of supply chains as economies make investments in physical and energy security. Some of the shift is being driven by geopolitical fault lines such as the deepening strategic rivalry between the US and China. 

He admits that he is cautious about China's economic prospects: China in and of itself is slowing down, something he views as both demographically and debt dynamics driven. He also noted the slower economic growth is politically driven, with shifts in policy directions that make it less attractive for direct investment. In addition, the property sector downturn driven by property debt is now added into the mix.

Then, there are subsidy wars, which Sturkenboom says are happening in technology and green technology as governments offer subsidies to onshore and re-shore manufacturing and supply chains in a way that is not necessarily economically efficient, but necessary to improve security.

Sustainable green transition 

Shipley notes the commonality between this theme and that of geopolitical fault lines on the issue of energy security. He notes how this has been felt keenly in Europe due to the Russian invasion of Ukraine. But it comes with challenges, namely the shift in that market to renewables:

"It's replacing something that works in the short run with something that requires investment" he said. 

And while there is a roll out of border adjustment taxes such as the carbon border adjustment mechanism (CBAM) in the EU, Shipley notes that countries don't want to fall behind. 

He also acknowledged that "support for the green transition is not equally distributed along the political spectrum". Yet he believes there is sufficient support for the transition to occur. Shipley reminded the audience that this transition is going to be hard, not only in terms of pricing but also meeting the demand for the raw materials needed to achieve net zero by 2050.  

Private markets are thriving

The analyst team notes that "liquidity through the secondary markets is promising" as they present their view of a thriving private ecosystem. The chart on the right shows the increased annual transaction volume over the last 10 years, while the chart on the left shoes how investment via direct lending, higher yield assets and bank loans has increased by comparing the levels in 2010 with those in 2020. 

What does this mean across the various asset classes? 

Taking the above themes and considering the impact across asset classes over the next 10 years, Northern Trust sets out their case across fixed income, equities, real assets and alternative assets. 

Fixed income: Not only are bonds back, their view is that negative interest rates are a thing of the past. While they predict there will be a default cycle, their current view is that this will be a more benign default cycle over the next 10 years given the spreads. 

Equities: Noting this will take "a team effort", they expect lower net 10-year returns from investments in the equities market, with a larger share of that return to come via dividends than from the traditional method of share price returns. Interest rates are a pressure on companies, not only in repricing existing debt but in taking on new debt. This is suppressing overall earnings and valuations. 

They have taken a look across a number of markets and their 10-year forecast is presented in the chart below:

Real assets: Northern Trust considers real assets to live under three buckets: natural resources, global real estate and global listed infrastructure. They are optimistic on natural resources but see an upwards pressure due to the pace of the green transition. 

"That pace may be slower than we're currently investing for when it comes to the legacy fossil fuels side of the equation. You may see some inflation here too, as we've seen recently in oil prices," said Starkey.

Alternative assets: With the theme of four premiums and a discount (private credit), the chart below presents Northern Trust's forecasts of 10-year annualised returns. 

They also call out hedge funds, which the team says are back after a poor decade from 2010 where that asset class struggled with interest rates, although the levels in the 2020s are nothing like the returns earned in the 1990s.

Tactical asset allocation 

Across the five major asset classes (cash, government bonds, high yield, private assets and equities), Starkey noted the firm's North American institutional clients have a "barbell" portfolio, with larger weights given to cash and private assets over the other classes. 

The mix in Europe is a little different on the institutional side, with government bonds becoming more attractive, but there is still a barbell strategy giving more weight to private assets and government bonds over the other asset classes. 

In terms of the firm's global policy model, the chart below shows the asset allocation across various asset classes, with the strategic asset allocation (SAA) in the second last column and the tactical asset allocation (TAA) in the last column.