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Multi-Asset: A decade of investment opportunities.

James Squires , Head of Multi Asset
Seismic shifts in the global order offer compelling opportunities for multi asset investors to dig deeper into the disruptors of key asset classes.

Greek philosopher Heraclitus is best known for his doctrine that everything is in flux. The world is ever changing, he said, using the flow of a river as an analogy: you can’t step into the same water twice.

Much of this is clearly true, but most change is not random. Rivers follow clear paths. And while not all of their bends and forks can be anticipated, their final destination often can.

When investing for multi-asset portfolios, Baillie Gifford investment managers keep these maxims in mind. Change means opportunity and the stronger the flow, the easier it is to see the ultimate destination. So we focus on those long-term trends, always looking to discern and understand the key changes that  will shape the investment world over the coming decades.

The next decades present great opportunities for the multi-asset investor. We stand at a point of major change in the world: on the precipice of several key developments that will change the economic and political landscape. Inevitable long-term trends that have important investment implications across a number of asset classes and will give rise to multiple, diverse opportunities.

These are the trends that guide our research and thinking. Trends that have already influenced our portfolio, but which are likely to do so even more in the future as we explore them further and gain greater conviction in the opportunities they present. The world is always changing, but the next decade should do so in a way that presents compelling opportunities and benefits investors in equities; infrastructure; real estate; commodities and a number of other asset classes besides.

For genuine multi-asset investors, those who can truly invest substantial proportions of their portfolios in those asset classes, it promises to be an exciting time.

In our portfolios, we exploit these themes, while presenting an optimistic macroeconomic view given the context of economies reopening and providing some certainty with a set of effective portfolio hedges.

The decade of opportunity 

The rise of Asia

 

The re-ordering of nations will be one of the biggest themes over the next 30 years. For the last few centuries it has been Europe, and then North America that have ruled the world, punching way above their weight in terms of wealth and economic supremacy. The story of the last three decades has been China’s rise but, as it came from such a low base, Europe and North America still make at least half of the world’s GDP despite contributing barely 15 per cent of the population. By contrast, Asia has 60 per cent of the world’s population but less than 40 per cent of economic production.

Over the next few decades, this calculus is due to change decisively. China will continue to grow and should comfortably surpass the US as the largest economy within the next 10 years. More significantly, India is expected to move from being a country on a par with some of the individual, major European countries to joining the same league as the US and China. Other Asian countries, such as Indonesia, should also begin to deliver more significantly on their potential as years of compounded high growth make a significant difference to the economic leader board of nations.

Putting all that together, the Economist Intelligence Unit forecasts that by 2050, China, India and the US will be the three economic powerhouses, each individually richer than the next five economies put together (a group led by Indonesia). This represents a significant change in the world order and a marked shift of the economic centre of gravity to the east.

Top ten countries worldwide by expected highest GDP in 2050

Such a seismic change presents both risks and opportunities for the multi-asset investor. On the one hand, volatility is inevitable – most obviously there will be political implications as China asserts its authority in international institutions and the US has to come to terms with no longer getting the freedom to set the terms of engagement. When new powers rub up against the established order, there is always friction. This will extend to international trade relationships; claims over natural resources; and which currency (if any) is seen as the world’s reserve currency. The United States (and to a lesser extent Europe) has much to protect, Asia much to gain.

There are also important hurdles to negotiate within Asia. The continent’s security architecture is more complex than that in other parts of the world. Interregional trade will be more important than trade with the old powers and freeing that is a necessary catalyst for the growth to come.

Assuming however that change is sufficiently gradual and well-managed, and that countries and regions work out how to exist in an equitable and productive way, this volatility should present great opportunity. Disruption is the flower of creation and for every disrupted country and business, there will be several who can experience new growth.

Such a seismic change presents both risks and opportunities for the multi-asset investor.

Our task is to identify and exploit the profitable growth. This could come through equities, as companies with a strong position in these new markets expand earnings and prospects. It could come through real estate as land values and incomes rise. It could come through infrastructure, whether the Belt and Road Initiative or, for example, India following China’s growth model and looking to create a power and transportation infrastructure at least as robust as that found in most western countries today. And such growth will inevitably see peaks in demand for certain commodities with the possibility of prices rising commensurately.

As these developments become more entrenched, so we would expect the risk premiums associated with these countries to fall, giving cause for multiples on risk assets to expand, yields on bonds (sovereign and corporate) to tighten and even currencies to appreciate. There are a great many potential opportunities for the multi-asset investor from this shift east.

Of course, it is not all plain sailing. Many a country through history has failed to live up to its potential, falling victim to the so-called middle-income trap, or becoming embroiled in disruptive disputes. And, for those countries that have seen rapid growth, it does not automatically follow that there are great returns to investors. China’s growth has in many ways been funded by international investors rather than benefiting them – growth built on the back of high levels of share issuance (dilution) and politically-directed corporate targets (focus on aims other than profit) that has reduced the returns to international investors. It is our privilege and responsibility to sort the wheat from the chaff and to have the opportunity to earn the benefits of this global dynamic.

Already this theme has a significant place in our investment portfolios. While most investment portfolios are very underinvested in China (a recent Greenwich Associates survey showed a typical allocation of 3–5 per cent to China among pension funds, endowments and foundations), our Multi Asset portfolios currently hold more than 12 per cent in China-domiciled assets, with additional investments in India, Indonesia and other Emerging Asia countries.

China allocation

Our largest China exposure is to mid-cap equities via outperformance notes. Noting the potential pitfalls above, there are several reasons to be excited by this investment:

Firstly, we can expect continued high earnings growth from a cadre of companies that represent the heart of the Chinese economy (this as opposed to the large-cap index which includes more of the State Owned Enterprises that focus on national priorities over shareholder returns and many of the largest independent companies whose very success has made them targets for government control and regulation).

Secondly, the price of these equities is unchallenging – we would expect the multiple of earnings at which they trade to expand over time. As the Chinese financial system is seen to mature and open up, so the effective risk premium that international investors apply to its assets should narrow.

Thirdly, the structure of our investments through a series of ‘outperformance notes’ sees our fund benefit from an additional guaranteed return over and above the mid-cap index total return. That additional return averages 10 per cent per annum, skewing the range of possible returns from this investment significantly in our favour.

Chinese mid-cap outperformance notes are just one way of accessing Asian growth. We are excited in different ways about our holdings of active equities; Indonesian government bonds and regional infrastructure stocks and we will continue to hunt opportunities to better capture the true potential that the transformative growth of India and other countries is likely to bring over the next decade and beyond.

World population in 2018

The country’s size in this map represents the size of the population.
Each square represents 500,000 people. All 15,266, squares show where the worlds 7,633 billion people live.

The green revolution

Few trends are likely to prove as significant over the next decades as climate action. The significance goes beyond investment and to the very habitability of our planet for future generations, with failure to achieve internationally agreed goals to limit temperature rises having severe consequences for the whole human race.

Climate change has been at the forefront of international discussions for 30 years or more. As long ago as 1990, UK prime minister Margaret Thatcher gave a speech at the World Climate Conference comparing the threat of global warming to war, referencing the Gulf War happening at that time: “The threat to our world comes not only from tyrants and their tanks. The danger of global warming is as yet unseen, but real enough for us to make changes and sacrifices,” she said. “Our ability to come together to stop or limit damage to the world’s environment will be perhaps the greatest test of how far we can act as a world community,” she continued. “We shall need statesmanship of a rare order.”

Despite the momentum that led to the agreement of the UN Framework Convention on Climate Change at the Rio summit of 1992, the series of annual global COP meetings on climate change that it sparked have yet to produce any meaningful accord limiting emissions. The actions agreed and taken to date have been largely token or misguided. Indeed, one might argue that statesmanship has been in stark retreat given the policy choices of Presidents Trump and Bolsonaro and the failure of almost every other major country to act decisively.

For all the fanfare around the Kyoto (1997) and Paris (2015) summits, the last 30 years have accelerated the climate disaster, not acted to mitigate it.  Even as coal – the most polluting of carbon energy sources – has decreased as a proportion of global energy production, its use has substantially increased in absolute terms. China has added 1,000 gigawatts of coal-fired power capacity (incremental Chinese coal demand has nearly doubled global coal demand from 1990, from 3 billion tons  to 5 billion tons) and India is primed to follow in its footsteps (followed by the rest of South-East Asia and Africa). Shipping and aviation – the most polluting forms of transport – have increased substantially, to say nothing of car use. Fertiliser production has intensified (this is hugely energy intensive), while land has been cleared and methane emissions continue to grow.

Societies have generally focused on their own economic growth with scant regard for how best to draw down on our natural capital to do so. Much as countries have racked up huge economic debts in recent years, so we have also racked up a huge environmental debt. However, this is a debt that we cannot just turn on the money printers to pay off.

The good news is that the collective desire to act is increasing.

In particular, the younger, more educated, better travelled and more environmentally aware cohort (namely generations X, Z and millennials in between) is becoming more significant politically and economically. These generations are increasingly controlling the political debate and within the next decade should form a clear majority in most countries.

Governments are being forced to listen and respond. Net Zero commitments have become de rigueur and there are hopes for stronger co-ordinated commitments to limit overall warming when leaders meet at COP-26 in Glasgow in November 2021. On an individual level, South Korea announced its Green New Deal; Germany its Package for the Future; while the Chinese government has put decarbonisation front and centre of its latest Five-Year Plan.

Companies are also in the spotlight. Those same generations are already, through social media and other channels, forcing the corporate debate. Companies can now be called out almost instantaneously for egregious transgressions and are generally preferring to move rapidly to boost their environmental credentials and fight for the green dollar. So Amazon runs advertisements that trumpet the wind farms powering their business rather than their products; Apple is aiming for Net Zero by 2030 (and is magnifying this right through its supply chain); Ikea and Unilever are ‘greening’ their supply chains; and so on. Niklas Höhne of the New Climate Institute observes that: “The transformation is starting small but is expanding fast. We find that in all areas, some actors are taking truly ambitious actions. For example, zero emissions targets and targets of 100 per cent renewables are spreading fast, but also commitments for zero emissions in heavy industry start to emerge unthinkable only a few years ago.”

Global CO2 Atmospheric Concentration

Global mean annual concentration of carbon dixoide (CO2) measured in parts per million (ppm)

Further good news has emerged from all the suffering and disruption of the Covid-19 pandemic. The world has shown itself, and its ruling elites, an ability to turn apparently immutable behaviours on a dime, with high obedience and little fuss when faced with a great threat (despite  news coverage, inevitably highlighting the disorderly few, not the compliant many). As Hannah Cloke, a professor at the University of Reading, noted in late 2020, “one of the great barriers to effective climate action is the scale of the lifestyle changes that are involved, including changing diets, driving less and taking fewer flights. The past six months have shown that all those things are possible when people are motivated enough to change.”

Nevertheless, the challenge of limiting temperature rises is a stern one – the UN Environment Programme Emissions Gap Report (2019) suggested that the required emissions decline to check global warming at a “safe” 1.5˚C is 7.5 per cent each and every year through to 2030. Many significant changes are called for if we are to meet this challenge. Each of those changes presents an investment opportunity for the multi-asset investor. An opportunity both to generate attractive returns and to support necessary environmental action.

Carbon emissions come from almost everything that rich countries regard as being part of a minimum standard of living: energy, transport, food, construction, and IT. We will need to change many aspects of how we live and the products we use; finding alternatives to current transport propellant (including greater use of communications networks); meat consumption and plastics among others.

The most obvious immediate focus is on the energy system. Great progress has been made on renewables in recent years, both technology and roll-out, such that renewables now account for the majority of new installed capacity. However, growth in energy demand has outstripped these new installations and fossil fuels still supply around 85 per cent of the world’s total energy. The transition to a clean energy system needs a few things to happen. Firstly, energy generation needs to switch to renewable sources. Secondly, we should electrify anything that can be electrified (cars, heating systems, industrial processes). Thirdly, we should find ways to offset anything we cannot electrify.

We are making good progress on the first of these and further policy and social support feels inevitable. However, the more grids rely on renewables, the greater the need there is to counteract the inherent variability in these natural sources. The traditional approach has been to rely on fossil fuel baseload power to smooth out variability, but in a new energy world it is likely that we will require better batteries and better, wider power grids to more efficiently move power around and avoid the sort of rolling blackouts that, for example, were seen in Texas in early 2021: there is always sun, wind or rain somewhere.

The second and third requirements are more of a work in progress, particularly in some developing countries where access to electricity of any sort cannot be taken for granted. Nevertheless, there are grounds for optimism with most major car manufacturers actively planning for an all-electric future and emerging technological developments in heat pumps, steelmaking and other areas. Energy efficiency is also getting greater focus, which is a key component of the balance between overall electricity demand and the burgeoning renewable supply.

Understanding the evolving technologies and likely direction of international and domestic policy to achieve these aims is a big focus of our research. We look to educate ourselves, engage with experts and interact with the companies at the frontier of this effort constantly. From this work, we hope to derive insights that lead to investment opportunities for the next decade across asset classes.

Already our portfolios are invested in commodity, equity and infrastructure opportunities that derive directly from this effort, while we consider the environmental credentials of all of our investments as part of our broader ESG analysis.

The equity and credit opportunity primarily lies in investing in the companies that bring the solutions to these problems: communications networks; battery technology; hydrogen production and distribution; electric vehicles etc. Our Baillie Gifford active equity and credit funds contain many investments on these themes.

The commodity opportunity comes though many of the metals that are likely to be in long-term demand to support sustainable technologies. In particular, copper, nickel, silver and rare earths are all, through their high conductivity or other special properties, essential to broad electrification. When supply of these metals fails to keep up with the demand, perhaps because of some other volatility, investments opportunities will present themselves. We have previously invested in nickel – a major component of electric vehicle batteries – on this thesis and are currently invested in silver – present in almost all electrical switches – for similar reasons. We may also choose to invest directly in carbon emissions futures.

One of the largest opportunities however is in the infrastructure asset class. Indeed, this was the conclusion of our recent Climate-Informed Long-Term Return Expectations exercise which ranked infrastructure as the most attractive asset class for passive returns over the next ten years (see page 13). This is where we are able to invest directly in both renewable energy project developers (‘renewable developers’) and production assets (‘operational renewable investment trusts’). Beyond these relatively obvious openings, the asset class presents many other more substantial investment opportunities linked to the climate theme.

Two of these are related to the need to substantially upgrade and extend national power transmission grids (and international connectors). Current grids are designed to take the energy generated by a small number of large power stations and distribute it to the many end users within those stations’ radius. The power grid of the future needs to be able to take energy in from lots of small stations (individual sets of wind turbines and solar panels) and distribute it where it is needed: a two-way system that is also extended to allow the import of energy from other regions when low sunshine or wind speeds demand it. This requires thousands of miles of new wires and more advanced wires. Conventional alternating current power lines lose a lot of energy over large distances, but high-voltage direct-current lines are much more efficient and economic – a 2,500km DC power line was recently installed linking hydro power stations in the Brazilian Amazon with Rio de Janeiro.

We contend that traditional regulated transmission and distribution utilities, the national and state champions that guard the grids in their respective regions, are likely to be well-incentivised to install these new miles of electrical architecture, as well as additional outlets such as electric vehicle charging points, smart roads and so on, with a number proving robust investments as a result. Moreover, the few companies that can produce the specialty high-voltage cables to power the electricity network of the new energy future should benefit from strong pricing and demand. Just as the makers of picks and shovels were the real winners of the gold rush, these ‘renewable suppliers’ may be the best investments of the bunch as we embark on the first leg of the green revolution.

Our climate-informed long term return expectations

Earlier this year, we produced a version of our Long Term Return Expectations paper (in which we forecast passive returns for whole asset classes out over the next decade and then the long-term beyond) that explicitly took into account climate policy and its success. We partnered with Ortecís specialist climate data team to consider three plausible pathways ñ two of which led to achievement of the Paris goals by limiting global warming to two degrees (relative to pre-industrial era temperatures), and one which saw policy failure – and sought to understand how each climate pathway would impact the long-term return potential of the major asset classes in our opportunity set.

Our conclusion was that investment returns will be higher across most asset classes if we manage a successful and orderly transition to a limited warming ñ sustainable investing pays, particularly over the long term. However, in keeping with earlier comments, we were also able to identify investments that should particularly benefit from that transition. Infrastructure stands out as a whole asset class, not least due to the necessary investments in clean energy generation and distribution infrastructure to enable decarbonisation. However, many asset classes will also present opportunities, either at the headline level or when we dive deeper into particular sectors. For example, in equities, we see a great number of climate-related opportunities for the truly active investor.

Technological innovation

Human ingenuity is perennially underestimated. The progress made in many fields over the last 100 years, whether health, wealth, education, security or human rights, has been astonishing. Nowhere is this more so than technology. Ten years ago, most people did not have a smartphone, could not have imagined a cashless society and certainly would not have been able to work from home with the relative ease that so many (but not all) have been able to through the Covid-19 pandemic.

Moore’s Law – the idea that the number of transistors that can be integrated into a microchip doubles every two years – has become something of a cliché but it represents well the exponential growth that has been observed in computing capacity and power and in other related fields, such as the number of human genome base pairs that can be sequenced or the number of pixels that can be purchased on a digital camera per dollar.

Number of human genome base pairs sequenced per US$, 2001 to 2015

This level of technological progress is perhaps exciting enough. However, it is our belief that Covid-19 has catalysed technological change and acceptance, particularly in the digital sphere.

Already we were seeing a substantial trend from the physical to electronic, led by Millennials and Generation Z – the first generations to have been brought up with the internet and smartphones as standard. As Azeem Azhar* puts it, during the 2020s “those in their mid-forties, who enjoyed their college years with the internet and careers with international colleagues from a young age, will graduate to be global leaders. The divisional work of large firms will be handled by those in their 30s today, a generation of the Internet, a group that understands how the Internet enable individual creators, self-organisation and innovation. The agitators and creators of our economy for the next decade are between 15 and 25 now. They grew up with the smartphone. The arrival of these younger cohorts into positions of power will shape the world deeply.”

However, the effect of Covid-19 has been to compel billions of people right across the world to stay home and to adopt technological solutions for work, leisure and essential shopping: abandoning travel, contact and physical shops for video calls, distancing and ecommerce. While we do not believe that these pandemic behaviours will remain wholly (the evidence of reopening has already shown a human desire for proximity and social contact), the length and enforced nature of the pandemic has made these solutions more normal, increasing their speed of take-up and the level of ongoing acceptance, insodoing catalysing the next decade of technological innovation.

This is a cause for great optimism. Technological innovation can drive growth, help solve the climate crisis and create the environment whereby innovators can disrupt incumbents and active managers adept at identifying the innovation can outperform and add real value.

Technological innovation also impacts our view of inflation and monetary policy. We see the impact of automation (broadly defined) as disinflationary, particularly where labour markets are concerned and when considering the production efficiency of goods. These are two of the factors that give us confidence in inflation remaining under control in much of the world over the medium-to-long term and central banks therefore being able to support economies as and when challenges crop up and that support is required.

New technologies also have a direct impact on our choice of individual investments. Many of the disruptive technologies are fundamental to the investments in innovators found throughout the Baillie Gifford growth equity funds in which our multi-asset portfolios invest. Current examples include Zoom, the now-ubiquitous video conferencing service provider; TSMC, a leading producer of semiconductors; and Meituan, a Chinese online shopping platform. All have benefited from behavioural changes during the pandemic and are likely to remain essential to the future rather than disappearing as society reverts to previous routines.

* Azeem Azhar is the start-up founder of tech companies PeerIndex and eSouk.

Technological innovation does not just benefit the equity investor.

The best-known example of a new technology-based investment among our equity holdings is probably Amazon.com, the global ecommerce giant that has been expanding into other areas such as web services and artificial intelligence and machine learning, while funding a range of moonshots to push the boundaries
of innovation to their extremes.

Technological innovation does not just benefit the equity investor. Amazon’s core activity and success has led the charge away from physical retail – high street outlets and similar – to ecommerce. This has opened up opportunities for the real estate investor. Our multi-asset portfolios have sold previous holdings of retail property funds and now have a meaningful investment in the logistics and fulfilment warehouses from which Amazon and its old-world peers now run their ecommerce activities. We own a number of real estate investment trusts (REITs) across the UK, US and Europe that focus in these logistics and fulfilment warehouses

As shopfronts become showrooms, so the demand for prime logistics sites to run retail distribution and newer business models, such as ‘dark’ grocery shops and kitchens, is increasing, creating an investment opportunity in real estate. One that sits alongside other potential opportunities in datacentres and communication towers – real estate and infrastructure investment opportunities that would not have existed 20 years ago, but which are now likely to be clear growth opportunities for the next decade.

As we innovate in technology, there are always new investment opportunities. These may come in many fields:

  • In energy, big steps forward in nuclear fusion generation techniques could be revolutionary and wireless electricity could catalyse electrification; these in addition to all the green technologies that are in development.
  • In computing, further improvements in artificial intelligence and natural language processing are very plausible, while blockchains and cryptocurrencies have the potential to revolutionise many of our systems, all turbocharged by unleashing the power of quantum computing more broadly.
  • Smart devices have already become ubiquitous, but wearables and intelligent spaces could lead to ‘augmented humans’ and truly smart cities.
  • In materials science, 3D printing and nanotechnology have a wide range of applications, disrupting supply chains and enhancing capabilities, while the amazing properties of graphene have yet to be fully exploited. The commodities demanded in the future may be quite different to those chased today.
  • In healthcare, there is increasing optimism that nanotechnology will bring significant advances to the diagnosis, treatment and prevention of disease. Combined with major advances in genomics and a greater public willingness to invest in healthcare solutions post Covid-19, healthcare should be an area of substantial innovation.
  • In communication, social media and virtual reality open up new opportunities, not least for more direct political engagement than in the past.
  • In transportation, autonomous vehicles and unmanned aerial vehicles have the potential to change how we move about and think about our infrastructure needs.
  • In many fields beyond these, there will likely be leaps that we haven’t yet even thought of.

We cannot say which, if any, of these will come to fruition. That is the nature of invention. However, what we can say is that our Multi Asset Team is fortunate to work with investment colleagues who have come to specialise in identifying the big disruptive technological trends. With hard work and a bit of imagination, the opportunities arising from identifying the impacts of these across the full range of asset classes in our investment universe are endless.

A multi asset portfolio for the next decade

The next decade looks set to provide a plethora of opportunities for the multi-asset investor who is willing to focus on imagination and not just diversification, return opportunities rather than simply risk avoidance.

The three themes discussed in this paper – the rise of Asia, the green revolution and technological innovation – are central to grasping that nettle, but others will also arise. After all, everything is flux.

We exploit these themes across our portfolio and the various asset classes we invest in. They also help guide our research agenda as we seek out newer and better opportunities. The chart over the page shows clearly how the three themes account for over half of our portfolio investments across a range of different asset classes. However, this is not the totality of our portfolio. As we combine the investment under these themes, we also wrap them with a number of investments that speak to our economic optimism as we see economies reopening and a few protective positions, or portfolio hedges.

Economies reopening

We expect the recovery from the pandemic to be a long and drawn out affair as Covid-19 continues to spawn variants of concern and different countries progress their vaccination programmes at varying paces. While this should support good levels of economic growth for a number of years, it will also have important policy impacts, including a continuation of the accommodative monetary policy regime and a renewed focus on healthcare and inequality.

At a corporate level, several travel and hospitality-linked industries are still operating at a fraction of their pre-pandemic capacity. Many companies have taken on extra debt to get through and, if they recover, will do so with a substantial additional burden. At the same time, the best companies in those industries with the strongest brands and balance sheets ought to be well-placed to take market share as economies reopen, presenting attractive investment opportunities.

Within our Multi Asset portfolios, we are invested in a bespoke Cyclical Recovery Equity Strategy. It is managed on our behalf by two senior Baillie Gifford global equity investors and is designed to exploit the opportunity presented by these leaders. Besides Ryanair, significant holdings in this part of our portfolios include CBRE, the real estate specialist; Royal Caribbean, a cruise line company and Whitbread, the UK pub operator. Our views on pandemic recovery also support a favourable view of prospects for high yield and investment grade credits, however offered spreads are typically low in mainstream markets.

 

Beyond a few select investments, we prefer to exploit the recovery opportunity in credit markets through the ownership of structured finance instruments – in particular, collateralised loan obligations, or CLOs – and two carefully-selected specialist private credit funds. In both cases, the niche nature of these markets permits higher yields and attractive potential returns. While the risks can be equally elevated, we believe our investments here strike the right balance of lower risk and higher yield versus the typical credit investment and should benefit from the continued recovery, while providing some valuable diversification to the portfolio as a whole.

Portfolio hedges

There is also a role for portfolio hedges. While the long-term themes are compelling and our belief in the ongoing recovery is strong, we must always be humble and recognise that we may be wrong, if only due to some random and inherently unpredictable event throwing the economy off course. Carefully selected portfolio hedges, that can be expected to provide a good pay-off in those moments of elevated market risk, without costing the portfolio during the good times, are valuable additions, helping to control overall levels of risk and giving us the freedom to take punchy and positive positions on those themes and investments where we see the strongest returns and in which we have the greatest conviction.

Ever since the Global Financial Crisis of 2007–-09, prudential regulators have moved to restrict the ability of banks to hold market assets on their balance sheets. While their rationale is wholly understandable, one consequence  is that banks have had to substantially withdraw from one of their previous activities which saw traders looking to arbitrage clear mis-pricings in securities markets. This has allowed a greater number of behavioural anomalies to come to the fore.

Many of these can be exploited systematically in a way that allows a modest expected return over the long term and it is here we typically look for portfolio hedges. While we generally set our bar for investment opportunities higher than ‘modest’ returns, some of these opportunities can be of interest when the nature of the strategy is essentially long volatility. These opportunities are interesting because long volatility positions typically serve to hedge a portfolio during times of economic uncertainty and sharp market falls.

One example of such a position in our portfolios is our investments in Equity Intraday Trend. The anomaly being exploited by this strategy is an established pattern whereby a significant market move at the start of a trading day more often than not becomes more exaggerated over the course of the day as more market participants assimilate the information and act upon it. Exchange traded funds (ETFs) can often be a significant part of this exaggerated activity as these passive strategies are forced to rebalance.

While this strategy can make money in all market conditions, the sharpest daily moves in markets tend to be downwards, and so the strongest returns reliably come at times of high volatility and panic, making this strategy an effective portfolio hedge.

The attraction of investments like this is that they provide portfolio insurance, but without extracting the heavy insurance premium that investments in VIX (volatility index) futures and index put options tend to carry. They are not all guaranteed to work at any one time, but a set of similar investments across a range of long-volatility strategies is far more likely than not to provide the protection that allows bold investments to be made and the largest returns
to be generated elsewhere as we seek to exploit the decade of opportunity ahead.

Summary reflections

It is change in the world that brings investment opportunities. Short-term changes can be as unpredictable as the meander of a river, but by concentrating on rooting out and understanding long-term trends, we believe it is possible to figure out the likely destination. The unrivalled opportunity set of our Multi Asset strategies gives us many ways to generate very attractive returns off the back of these.

Some of the key trends that define the next 10 and 20 years are likely to be the rise of Asia, the green revolution and technological innovation – big themes with big consequences that are likely to see the world of 2050 in many ways unrecognisable from the world we live in today. We are already investing with these themes in mind, but they are also the inspiration for much of our ongoing research and are likely to provide as many, if not more, opportunities ahead than they have to date.

It is our job and our privilege to be on top of these opportunities. As we investigate and invest in these, and other trends, we do so through a set of portfolios that seek to capture the optimistic economic mood of the day while retaining the humility to maintain a solid defence against misjudgements or short-term downswings.

We believe this gives us the best chance of making the most of the decade of opportunity ahead.

 

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Risk factors

The views expressed in this article are those of James Squires and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in September 2021 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Potential for Profit and Loss

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

Stock Examples

Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.

This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this article are for illustrative purposes only.

Important information 

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.

Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.

Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.

Europe

Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018 and is authorised by the Central Bank of Ireland. Through its MiFID passport, it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Similarly, it has established Baillie Gifford Investment Management (Europe) Limited (Amsterdam Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in The Netherlands. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions (“FinIA”). It does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. It is the intention to ask for the authorisation by the Swiss Financial Market Supervisory Authority (FINMA) to maintain this representative office of a foreign asset manager of collective assets in Switzerland pursuant to the applicable transitional provisions of FinIA. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co.

Hong Kong

Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 and a Type 2 license from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 can be contacted at Suites 2713-2715, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. Telephone +852 3756 5700.

South Korea

Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.

Japan

Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.

Australia

Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth) and holds Foreign Australian Financial Services Licence No 528911. This material is provided to you on the basis that you are a ‘wholesale client’ within the meaning of section 761G of the Corporations Act 2001 (Cth) (‘Corporations Act’). Please advise Baillie Gifford Overseas Limited immediately if you are not a wholesale client. In no circumstances may this material be made available to a ‘retail client’ within the meaning of section 761G of the Corporations Act.

This material contains general information only. It does not take into account any person’s objectives, financial situation or needs.

South Africa

Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.

North America

Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.

The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission (‘OSC’). Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford International LLC is regulated by the OSC as an exempt market and its licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.

Oman

Baillie Gifford Overseas Limited (“BGO”) neither has a registered business presence nor a representative office in Oman and does not undertake banking business or provide financial services in Oman. Consequently, BGO is not regulated by either the Central Bank of Oman or Oman’s Capital Market Authority. No authorization, licence or approval has been received from the Capital Market Authority of Oman or any other regulatory authority in Oman, to provide such advice or service within Oman. BGO does not solicit business in Oman and does not market, offer, sell or distribute any financial or investment products or services in Oman and no subscription to any securities, products or financial services may or will be consummated within Oman. The recipient of this material represents that it is a financial institution or a sophisticated investor (as described in Article 139 of the Executive Regulations of the Capital Market Law) and that its officers/employees have such experience in business and financial matters that they are capable of evaluating the merits and risks of investments.

Qatar

The materials contained herein are not intended to constitute an offer or provision of investment management, investment and advisory services or other financial services under the laws of Qatar. The services have not been and will not be authorised by the Qatar Financial Markets Authority, the Qatar Financial Centre Regulatory Authority or the Qatar Central Bank in accordance with their regulations or any other regulations in Qatar.

Israel

Baillie Gifford Overseas is not licensed under Israel’s Regulation of Investment Advising, Investment Marketing and Portfolio Management Law, 5755-1995 (the Advice Law) and does not carry insurance pursuant to the Advice Law. This material is only intended for those categories of Israeli residents who are qualified clients listed on the First Addendum to the Advice Law.

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Author

James Squires

Head of Multi Asset

James is Head of the Multi Asset Team and chairs our Multi Asset and Income Leadership Group. He became a Partner in 2018. James joined Baillie Gifford in 2006, initially working in our North American Equity and Fixed Income Teams. He has been a CFA Charterholder since 2010 and graduated BA in Mathematics and Philosophy from the University of Oxford in 2005.

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