For example, just stop and consider last year’s development of COVID-19 vaccines, made possible by lightning-fast genomic sequencing. The Human Genome Project began in 1990 as an international research collaboration to determine the base pairs that make up human DNA—it took 13 years to complete. Scientists can now sequence an entire human genome overnight, and for less than the cost of a business suit. Just as miraculous, the time it took pharmaceutical companies such as Moderna to develop a COVID-19 vaccine based on that sequencing was a mere two days. Genomic mapping at this speed and cost opens up immense possibilities for personalized medicine, a market estimated to approach US$3 trillion globally next year.¹
We look at three areas in which dramatic change is establishing new paradigms and new ways of thinking: the low-carbon transition, the rapid digitization and rising wealth of emerging-market economies, and the adoption of new strategies in the search for yield.
The low-carbon transition
The goal of the 2015 Paris Agreement is to limit global warming to well below 2ºC relative to preindustrial levels. Meeting this goal requires that countries reach peak greenhouse gas emissions as soon as possible so that, together, we achieve a carbon-neutral world by 2050. This shift to a low-carbon global economy would likely affect nearly every facet of our lives; for example, even as worldwide electricity generation nearly doubles in the coming decades, the share of electricity generation represented by renewable energy would increase from 24% in 2015 to 85% by 2050.² Actions taken since 2015 have already sparked low-carbon solutions and new markets across the global economy, most visibly in the power and transport sectors. The world’s largest automobile manufacturers have announced plans to eliminate the internal combustion engine (ICE) from their production lines, while governments around the world have set timeframes for achieving zero vehicular emissions. It’s estimated that electric vehicle sales could surpass ICE sales globally before 2050.³
The rising importance of solar and wind energy in the power sectorBreakdown of electricity generation by source (TWh/yr)
Source: International Renewable Energy Agency, Global Energy Transformation: A Roadmap to 2050, 2018. This scenario includes the deployment of low-carbon technologies, based largely on renewable energy and energy efficiency, to generate a transformation of the global energy system that limits the rise in global temperature to well below 2 degrees Celsius above pre-industrial levels. The scenario is focused on energy-related carbon dioxide emissions, which make up around two-thirds of global greenhouse gas emissions.
Of course, there are significant risks as well as opportunities in the transition to a low-carbon economy, and understanding the implied financial risk is a core feature of sustainable investing—and a goal supported by the United Nations’ Task Force on Climate-related Financial Disclosures (TCFD). According to the TCFD, the shift to a low-carbon economy will require trillions in invested capital and may entail extensive policy, legal, technological, and market changes to address mitigation and adaptation requirements related to climate change. Depending on the nature, speed, and focus of these changes, transition risks may pose varying levels of financial and reputational risk to companies.
The spectrum of climate-related transition risk for global equities
The dynamic nature of this multifaceted transition argues for an active investment approach in two ways. First, the shift in the composition of economic sectors cannot possibly be contemplated by today’s capitalization-weighted benchmarks; tomorrow will look different, and some of today’s biggest corporations by market cap may no longer play as big a role. Second, active managers have the ability to influence portfolio companies through active engagement to help improve the likelihood of success.
Transformational change in emerging markets
For decades, emerging markets have been viewed as natural resource economies, where commodities-oriented industries ship materials at low cost to fuel the economic engines of wealthier, more developed countries. Today’s reality is far different. Markets across Asia and Eastern Europe are benefiting from rising domestic consumption powered by a growing middle class, digital transformation, and a sea change in the economic mix of businesses.
One measure of this change can be found in the composition of the market-cap-weighted MSCI EM Index. A decade ago, energy/materials held a weighting in the index roughly equivalent to the consumer discretionary, technology, and communication services industries combined. Today, energy/materials (12.9%) is dwarfed by those other industries, which have swelled to nearly 50% of the benchmark.
Emerging markets are shifting toward faster-growing tech and consumer sectors
Source: MSCI Inc., 2021. Data as of December 31 of each year. The MSCI Emerging Markets Index tracks the performance of publicly traded large- and mid-cap emerging-market stocks. It is not possible to invest directly in an index.
One reason why this trend is likely to accelerate is that in places such as India, digital transformation is public policy. The foundation of India’s digital economic potential was laid in 2014 when the country’s government began the process of formalization (bringing its largely small-scale, cash-based economy into a more accountable, modern infrastructure). It was a necessary step, as India’s informal sector employed 90% of its workforce but contributed only 50% of GDP, significantly dragging down overall productivity.⁴
Every adult in India was given a bank account and a 12-digit unique identity number linked to a mobile phone number. Called the JAM trinity, it empowered people to conduct cashless, paperless, and presence-less transactions through formal channels. The formalization agenda coincided with the onset of 4G telecom networks, rising internet penetration, and the availability of online products and services.
Critically, the JAM trinity leveraged India’s emerging telecom infrastructure to bring thousands of businesses into the formal banking channel. This move coincided with the increasing availability of smartphones and led to explosive growth. The penetration of 4G jumped from 8% in 2016 to 49% in 2019, and average mobile data usage jumped 8x, to 11.2 GB per user, per month, between 2016 and 2019.⁵ As new e-commerce business models emerged, India’s internet economy attracted significant capital from the likes of Walmart, Amazon, and Facebook. The value of India’s e-commerce is now expected to surpass that of the United States by 2034, with a compound annual growth rate of roughly 27%.⁶
India’s e-commerce is now expected to surpass that of the United States by 2034, with a compound annual growth rate of roughly 27%.
Like the transition to a low-carbon economy, the changes taking place today in the world’s most populous regions present both opportunities and risks for investors, as new economic winners and losers emerge in the years ahead.
New strategies in the search for yield
Institutional investors have grappled with the decline in global sovereign yields for years. This long-running trend intensified during the pandemic, with central banks introducing new stimulus programs and investors taking cover from volatile equity markets. By year-end 2020, negative-yielding debt topped a record US$18 trillion globally, and Canada’s 10-year bond yielded just 69 bps at year end—below the rate of inflation.⁷ Even after an uptick in rates this year, many developed-market yields remain below 1% and are negative on an inflation-adjusted basis.⁸ Public pension plans will continue to seek new sources of yield to meet their liabilities.
Private markets strategies seek to offer a number of new ways for investors to pursue strong risk-adjusted yields. For example, higher carbon prices, in combination with increasing acceptance of carbon credits, could provide added revenue to timber and agriculture holdings, offering greater optionality in the operation of properties and potentially augmenting land values. These new carbon-based revenue streams could trigger a paradigm shift in natural resource investments. The current emphasis on crop yield and financial crop return could broaden into new strategies focused on achieving the most cost-efficient capture and storage of carbon to meet investors’ environmental goals. Already, the widespread acceptance of forest carbon offset credits has fostered the growth and development of active markets for the trading of carbon stored in forests, and a path for timberland owners to capture value from the carbon capture and storage capabilities of their forests.
Carbon prices have moved upward since the Paris Climate Accord
Private credit provides another example. When paired with the right partners, long-term investors allocating to private credit stand poised to enjoy higher yields, lower price volatility, and broader diversification benefits when compared with those who limit their portfolios to stocks, bonds, and bills. While fixed-income investors move in and out of holdings via a highly liquid secondary market, direct lenders, or private credit investors, generally enter into long-term relationships with their borrowers. The arrangement affords private credit investors an opportunity to capture an illiquidity premium over yields of comparable quality bonds and bank loans.
Private credit's yield premium provides lenders a comfortable cushion
Current yields, March 31, 2021 (%)
Source: Bank of Canada, Deutsche Bundesbank, Cliffwater, FactSet, Ministry of Finance (Japan), U.S. Treasury, March 31, 2021. See notes below for the list of asset class proxies9
An active endeavor
A common thread that runs through these dramatic changes is the role that investment research, portfolio management, and active stewardship of real assets can play in creating better outcomes for investors. At Manulife Investment Management, our 95+ year heritage of investing in real assets today is complemented by an investment footprint that spans 18 geographies as of March 31, 2021, and includes a sophisticated fixed-income team in Asia, one in which embedded analysts collaborate with colleagues across disciplines and geographies —including our ESG team—to develop a clearer picture of potential risks and opportunities. No matter how quickly the investment landscape evolves in the years ahead, our goal is to help investors realize the possibilities.
1 Statistica estimates: Grand View Research, 2018. 2 International Renewable Energy Agency, A Roadmap to 2050, 2018. 3 Wood Mackenzie, February 2021. 4 Confederation of Indian Industry, October 2014. 5 Individual company reports of Idea, Vodafone, and Reliance Jio, JP Morgan, 2016-2019. 6 India Brand Equity Foundation, 2021. 7 FactSet, December 31, 2020. 8 Bloomberg, June 2021. 9 Private credit (including junior): Cliffwater Direct Lending Index; private credit (senior only): Cliffwater Direct Lending Index: Senior Only; U.S. high-yield bonds: Bloomberg Barclays U.S. Corporate HY Index; U.S. corporate bonds: Bloomberg Barclays U.S. Corporate IG Index; U.S. core bonds: Bloomberg Barclays U.S. Agg Bond Index; U.S. Treasury notes: Bloomberg Barclays U.S. Agg Securitized MBS Index: 10-year Canadian government bonds: 10-year; short-term U.S. Treasury bills: Bloomberg Barclays U.S. Short Treasury Index; Japanese government bonds: 10-year; German government bonds: 10-year.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
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