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Five insights in five minutes

Five in Five: real yields, Europe, China, greenium, natural capital
24 September 2021

    Real income

    The word ‘real’ pops up in economics and investing all the time. But calculating returns after inflation is not something most of us do day-to-day. Do you know your portfolio’s real performance over the last decade? How many readers inflation-adjust their salaries in their minds each year? Likewise, even when desperate for income, it is easy to lose track of which asset classes are currently generating a positive real yield and which aren’t – kind of important if you want your wealth to increase. The chart below, therefore, is here to help. First thing that jumps out is that five of the top eight asset classes with a positive real yield are in emerging markets. US fixed income makes up most of the bars in the red. After the ructions over the past month, Chinese stocks and credit are now yielding more than three per cent – emerging equities seem particularly compelling at almost four per cent. For investors wanting more geographic diversification, global high yield at two per cent is not to be sniffed at given near-zero policy rates around the world.

    Ways to play: emerging market equities, global high yield

    Real income  

    Europe bounces back

    This weekend, Europe’s largest economy holds a federal election. Polls reckon change is coming to Germany, but whoever declares victory will be supported by healthy eurozone activity. Output growth was two per cent last quarter, with a full recovery to pre-pandemic levels now expected in the penultimate three months of this year. So about now. As we note in our most recent Europe Insights publication, the post-Covid rebound has been swifter compared with the financial crisis, with more resilient capex despite similar government support, as shown in the chart below. Indeed, eurozone private investment now stands only half a per cent below its pre-pandemic level, whereas even two years after the start of the financial crisis, eurozone output remained 4.4 per cent shy with an investment shortfall of 14 per cent. Why should investors care? Because while everyone has been watching America or China, European equities indices have quietly outperformed the lot, up almost 20 per cent year to date in local currency. Pan-European high yield returns have topped five per cent too since January.

    Ways to play: Europe equities, Europe credit

    Europe bounces back  

    Sector divergence in China

    Most Chinese stocks are struggling to be prosperous to say the least, with MSCI China down 17 per cent year to date. Markets hate uncertainty, so it is not unreasonable for investors to assign higher risk premiums to industries where firmer regulation is possible in the future. But don’t forget the opposite is also true, specifically for sectors that have been maturely regulated for a while. Looking at the chart below, for example, energy leads the pack with a 45 per cent gain year to date, unfazed by recent concerns. Not far behind are materials and utilities, both up more than a fifth. One particular sector that catches the eye is financials. It is huge and already more regulated than most industries, and yet its relative performance has suffered (for obvious reasons of late). But MSCI China Financials has a price-to-book ratio at a record low 0.6 times and price-to-earnings at a near rock-bottom 5.1 times. And banks are even paying nice dividends.

    Ways to play: China equities

    Sector divergence in China  

    The ‘greenium’

    Countless research papers have shown that, in the past, taking environmental, social and governance factors into consideration when investing boosts returns. But what matters for investors is the future. How does ESG influence forecasting? Our investment strategy team has been working late and its proprietary model now produces long-term expected returns for both ESG and non-ESG aligned asset classes – for example using the MSCI ESG Leaders family of indices for the former. The output shows that, overall, equity market investors can access the ESG theme without any material drop in expected returns. Indeed, ESG indices in developed markets offer potentially higher returns, as can be seen in the chart below for Japan, America, the UK, US and Europe. Of course there are risks around all expected return frameworks. But as the debate rages over the existence and size of a so-called ‘greenium’ (the excess paid to invest sustainably) our strategists show that if it exists at all, it is small for global assets, and for developed equities it’s negative.

    Ways to play: ESG funds, ESG ETFs, sustainable benchmarks

    The ‘greenium’  

    Green bonds and natural capital

    As if to beef up (or even better for the environment, tofu-up) its credentials ahead of hosting the COP26 summit on climate change, the UK this week joined the ranks of governments around the world issuing green bonds. The result was record demand, with investors willing to pay a premium for bonds that fund projects related to carbon capture, for instance. But there is already someone with a tried and tested approach to the grabbing and sequestration of emissions – mother nature herself. As per the chart below, the world’s natural assets absorb over 40 per cent of carbon emissions. As important, more than half of global gross domestic product is moderately to highly dependent on nature, calculates the World Economic Forum. Hence natural capital is easily the biggest income generating asset class on the planet. Yet ongoing negligence means an estimated $8 trillion of investment is now required by 2050 to tackle the interlinked climate, biodiversity, and land degradation crises. That’s a quadrupling versus today and a massive opportunity for investors indeed.

    Ways to play: natural capital, green bonds

    Green bonds and natural capital 


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