The past few years have been eventful for investors. Not only have we experienced a global pandemic, rising geo-political risk, and massive fiscal and monetary interventions—but rising inflationary pressures and higher interest rates have also rattled investors. As markets adjust to the reality of higher long-term interest rates and persistent inflationary pressures, it appears increasingly likely that 2024 will be characterised by another year of market volatility.
In March, LGT Crestone held its annual symposium in Brisbane, Melbourne and Sydney, where we discussed whether investors should brace for another year of volatility, and where we see the opportunities and risks for investment portfolios.
Scott Haslem, Chief Investment Officer at LGT Crestone, provided an overview of the macro-economic environment. This was then followed by a debate about whether public or private markets will outperform in 2024. The debate featured Juan Delgado-Moreira, Co-Chief Executive Officer at Hamilton Lane, and Mark Burgess, Former Managing Director and President of the Future Fund. The discussion was facilitated by Kevin Wan Lum, Deputy Chief Investment Officer at LGT Crestone.
The audience then asked questions to our panel on the opportunities and risks across asset classes. Our panellists included Amy Xie-Patrick, Head of Fixed Income Strategies at Pendal Group, Andrew Lockhart, Managing Director at Metrics Credit Partners, John Henderson, General Partner at AirTree Ventures, and Todd Hoare, Head of Public Markets at LGT Crestone. The panel discussion was facilitated by Scott Haslem.
If inflation has a higher resting heartbeat, this means that interest rates will also likely be higher, which is positive for fixed income returns.
By allocating a proportion of their portfolio to alternatives, investors can benefit from the low correlation to traditional asset classes.
Haslem reminded the audience that a year ago we believed we were entering a new phase for investment markets. Today, we are now in that phase, which is characterised by slowing growth, falling inflation, as well as interest rates that are expected to decline in H2 2024. Haslem explained that this change from rising rates and inflation to falling rates and inflation is expected to create some volatility in markets. Added to this, more than half the world’s population will go to the ballot box this year, which is also expected to contribute to market volatility.
From a structural perspective, moderating inflation and interest rates is not the worst backdrop for investment markets. If inflation has a higher resting heartbeat, this means that interest rates will also likely be higher, which is positive for fixed income returns. To counter the effects of increased volatility, Haslem explained that alternatives have an important role to play.
“By allocating a proportion of their portfolio to alternatives, investors can benefit from the low correlation to traditional asset classes, and enhance the diversification benefits in portfolios. An investment in alternatives can also provide exposure to certain themes, such as inflation protection.”
From a cyclical perspective, Haslem explained that at LGT Crestone, we are not taking large bets across asset classes, but instead looking for opportunities within asset classes. At an asset class level, fixed income remains our highest conviction, and we are neutral equities. Overall, we believe that fixed income will perform well relative to equities under several scenarios in the short term, and we are underweight cash, reflecting our view that rates have likely peaked.
Haslem also provided his perspective on some of the themes currently playing out in investment markets:
Are we really dealing with ‘sticky’ inflation? At LGT Crestone, we believe inflation is falling, but there will likely be long and variable lags before it reaches respective central bank targets. For investors, this means that fixed income likely has further to run, so it is important that investors do not jettison their fixed income exposures too early.
There is long-term support for Japan, underpinning the argument for a long-term strategic allocation in investment portfolios.
Are Japanese equities worth a strategic allocation? Haslem explained that in Japan, the jobs market is tight, consumer credit is rising, and house prices are driving wealth. Corporate governance has also improved, and service sector activity is at its strongest level since 1989. This provides long-term support for Japan, underpinning the argument for a long-term strategic allocation in investment portfolios.
If there really is an artificial intelligence (AI) bubble, are we closer to the beginning or the end of that bubble? While this question is still subject to debate, some would argue that we are not in a bubble, and that a new industry is being formed, which is driving growth in the sector.
Should investors still be underweight European equities? With services and manufacturing activity recovering in some countries, this could support a higher weighting to European equities. Energy supply is also less of a risk, and fiscal policy will likely need to respond to the US Inflation Reduction Act to protect the European Union’s competitiveness relative to the US.
Does manager selection still matter? Haslem explained how the dispersion between the best and worst-performing managers in private markets can be as much as 20 percentage points (versus just several percent in public markets). This highlights the importance of manager selection, particularly when investing in alternatives.
The dispersion between the best and worst-performing managers in private markets can be as much as 20 percentage points. This highlights the importance of manager selection.
Kevin Wan Lum, Deputy Chief Investment Officer at LGT Crestone, facilitated a debate between Juan Delgado-Moreira, Co-Chief Executive Officer at Hamilton Lane, and Mark Burgess, Former Managing Director and President of the Future Fund. The discussion focussed on what they see as the drivers of returns in public and private markets, and where they believe investors should deploy capital in the year ahead.
Delgado-Moreira explained that returns in alternatives come from value creation, not from “buying cheap and selling high”. Although some may believe that valuations in alternatives are no longer cheap, he sees them as generally fair, and he does not expect them to fall aggressively from here.
“Hamilton Lane’s investments have multi-year holding periods, allowing us to unlock value in companies we partner with, and this is where returns come from.”
Burgess believes we are entering a different environment with increased volatility. In this environment, portfolio positioning and manager selection will be a greater contributor to returns. This is in contrast to the key driver of returns over the past few decades having been the tailwind from falling interest rates.
“In the next period, I see rates going sideways. The next period will be about good advice. Skill will be the value-add—not just the tailwind of falling rates.”
It is important to monitor liquidity risk when investing in private markets. Liquidity needs can change as different events take place in an investor’s life.
Delgado-Moreira commented on the misconception among some investors that private equity is a tech or leverage play. On the contrary, he explained that it is now more mid-market and more fundamental. Similarly, buy-out is now much better levered and better run that it has been previously. Delgado-Moreira also explained that, in some places, venture capital is considered a “dirty word”, unless it is associated with AI. However, he feels that it currently represents an attractive investment opportunity, as this is an area where relative value can emerge.
“There’s never been easier access to premiere venture funds. They’re now finding it much harder to raise [capital], and innovation as a fundamental driver of returns is not going away.”
Burgess explained that it is important to monitor liquidity risk when investing in private markets. Investors are allocating a reasonable percentage to alternatives to capture the illiquidity premium, but this needs to be carefully monitored, as liquidity needs can change as different events take place in an investor’s life. For institutions, Burgess explained that liquidity risk is monitored continuously, with portfolios subjected to rigorous scenario testing.
It will be important for investors to “pick the eyes” out of public and private markets.
In 2023, listed equities returned 23.2% (as measured by the MSCI World ex-Australia Index). Burgess explained that one of the reasons for this strong performance is because listed markets provide a transfer mechanism, allowing investors to deploy cash quickly. He believes it will be important for investors to “pick the eyes” out of both markets. With yields attractive, private credit and bonds both represent an attractive investment opportunity.
Haslem facilitated a panel discussion on the opportunities and risks for 2024 across fixed income, private credit, venture capital and listed equities. Our panellists were Amy Xie-Patrick, Head of Fixed Income Strategies at Pendal Group, Andrew Lockhart, Managing Director at Metrics Credit Partners, John Henderson, General Partner at AirTree Ventures, and Todd Hoare, Head of Public Markets at LGT Crestone.
The greatest risk for fixed income is a no-landing scenario. This also presents a risk for equities, as the two classes are positively correlated.
Xie-Patrick feels the greatest risk for fixed income is a no-landing scenario, which is commonly defined as when growth stays at or even above its long-term potential. While her base-case scenario is for the economy to experience a soft landing, her conviction is not strong, as there is evidence from recent data that the consumer is buoyant and still spending. Not only does a no-landing scenario present a risk for fixed income, but she believes it also presents a risk for equities, as the two classes are positively correlated. With 2024 expected to bring increased market volatility, Xie-Patrick will be looking to buy debt across the risk spectrum.
“Fixed income is generally there for the bad times—but investment grade credit, above anything else, gives you the best risk-adjusted returns over the long term. And this is particularly the case for Australian investment grade credit.”
In private credit, look for companies that are appropriately capitalised, that provide good, stable cashflows, and where there are pockets of dislocation.
Lockhart commented on how risk-adjusted returns are currently attractive in private credit and that, as a lender, Metrics Credit Partners looks for companies that are appropriately capitalised, that provide good, stable cashflows, and where there are pockets of dislocation. He sees an opportunity in Australia, where he expects there to be ongoing dislocation.
“This is largely a reflection of the market’s smaller size, which means that corporates are not able to raise debt in an efficient way.”
For venture capital, there is now critical density of innovation and experience in the Australian market that previously did not exist.
Henderson explained that to be successful in the venture capital industry, you need to be good at both venture (i.e., making excellent investments) and capital (i.e., returning money to your investors). He added that there is now a critical density of talent, experience and capital in the Australian market that previously did not exist. He explained that AirTree Ventures is particularly attracted to software companies with sustainable business models. In the AI space, it sees the best opportunities in companies building businesses in the application layer, where Australia has typically had an advantage.
"In AI, the hardware and infrastructure layer is the natural domain of large global players, like Nvidia. We're excited to see the capabilities and models of these layers applied to specific use cases, where we'll see new business models built that don't exist today."
With regards to AI, Hoare added that investors should be looking to companies that can use AI to increase productivity and reduce costs.
“It won’t just be application software. [AI] will be pervasive across a number of different avenues.”
In listed equities, investors should be looking for opportunities within sectors, within regions, and within capital structures.
Although LGT Crestone is constructive on listed equities in the short term, Hoare explained that one of the issues investors will need to grapple with is concentration risk. Referring to how the top 10 stocks in the world represent approximately 20% of the market, he commented on how it is important for investors to avoid the notion of being “bullish or bearish an index”. Instead, investors should be looking for opportunities within sectors, within regions, and within capital structures. Within listed equities, he currently sees opportunities in small- and mid-caps. The valuation discount of small- and mid-cap equities versus large-caps is now more attractive than it has been in over a decade. However, despite their potential to generate returns in excess of the benchmark, allocations to this part of the market are still typically under-represented in investor portfolios.
“The search for alpha is now much broader than it was previously. Small and mid-caps have not participated in this rally, and they’re quite cheap.“
We polled our audience to gauge their current thinking about investment markets. Our audience overwhelmingly expects private markets to outperform public markets in 2024, with a relatively even split between private equity and private debt.
This report reflects discussions held during the Symposium event held in Sydney.
Our Melbourne and Brisbane events featured additional speakers, including Elicia McDonald, Partner at AirTree Ventures, Marcus Darville, Managing Partner at Quadrant Private Equity, and Leila Lee, Partner at Square Peg.
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