After a year of pandemic induced turmoil in investment markets, superannuation funds are facing greater complexity and thematic shifts across asset classes and sectors, according to chief investment officers at the recent 2021 Association of Superannuation Funds of Australia conference.

The overriding factors shaping the market in the year ahead will be the continued challenges of a near-zero interest rate environment; finding investment opportunities as a COVID normal emerges; and an increased focus by investors on climate change and the environment, speakers told the conference.

In a panel session titled Capital markets: the challenges and the end game, chief investment officers of super funds and investment firms discussed the move by central banks to inject huge waves of liquidity around the world in response to the COVID-induced recession, pushing cash rates down to zero.

During the recovery from the Global Financial Crisis, investors were able to achieve real returns of at least 2% for cash alone.  Now however, real interest rates are at zero or negative in many advanced economies, so that all returns must be generated from real assets.

This has made the job of strategic asset allocation more difficult and requires increased diversification to alternative sources of return, particularly with bond yields so low. “We need to think more deeply and in a more nuanced way about how we allocate assets,” the panel was told.

Managing liquidity in superannuation funds will take on greater importance, as the past year demonstrated.

Funds came under additional pressure at the height of the market volatility when the federal government allowed members to draw down their balances in cases of financial hardship. The rush of some A$39 billion of member withdrawals came just when asset prices were at their lows, locking in losses and placing additional cashflow strains on funds.

Worries about inflation resurface

As governments took steps to insulate economies from shutdown-induced recession with massive stimulus and support programs, central banks slashed interest rates and made large-scale purchases of government bonds, raising fears for some investors this will reignite inflation risks.

Just how central banks extricate themselves from the excess liquidity flooding markets and whether that will generate long-absent inflation was front of mind for the investors on the panel.

Harking back to the late 1970s and early 1980s when central banks “went nuclear” in trying every possible strategy to get runaway inflation down to acceptable levels, triggering severe recession, the conference heard monetary authorities are now at a similar point in their attempts to revive inflation to help lift economic recovery. “They will ultimately get what they want in terms of higher inflation,” one speaker said.

Increased focus on ESG

Against initial expectations, the pandemic has intensified awareness of environmental, social and governance (ESG) issues and reinforced the importance of sustainability for investors. There is a growing global awareness that sustainable companies are more resilient to shocks.

In Australia, flows into sustainable or responsible investments continues to rise and comprise close to 40% of professionally managed assets in Australia[1].

One panellist told the conference they consider ESG issues such as climate risk in their portfolios from both a short-term and long-term perspective.

In the short term, there’s the risk of direct exposure to carbon emissions and the expectation of an inevitable policy response and a price on carbon. Longer term is the risk across the portfolio of a sustained rise in global temperatures above the 1.5 degrees Celsius that is considered manageable.

“To really have a role in managing the long-term climate risk in the portfolio requires us to drive change in companies that have those shorter-term risks,” the conference heard.

Winners and losers

While Australia has, to date, recorded a remarkable recovery, some parts of the economy continue to face sector-specific headwinds. Superannuation funds will need to assess what the “new normal” will look like across sectors. For instance, commercial property is likely to fare worse than industrial property and logistics as office workers continue to spend more time at home.

One panel member told the conference this will open up opportunities for active managers to use their discretion in picking winners and losers in equity markets.

“We’re going to see much greater dispersion in the recovery from this crisis than we saw post the Global Financial Crisis. It’s not going to be a case of a rising tide lifting all boats and active managers will show their worth,” the panel member said.

[1] https://responsibleinvestment.org/resources/benchmark-report/