CIO views: finding value through patient investing

Aurèle Storno CIO, Multi Asset

Passive investing assumes that past trends are guides to future returns and ignores selectivity; it goes with the flow and buys everything without judgement. Based on such logic, our multi-asset strategies would have had insufficient exposure to direct and indirect inflation hedges in 2022-23 – for example to commodities and inflation swaps – and our strategy’s performance would have suffered¹.

Active investing is about making choices and taking responsibility. By our DNA we are patient investors, and it permeates everything we do. 

Firstly, we are patient process builders: research takes time. It took us 15 years to reach the current state of our process, going through patient analysis and research, and progressive enhancements. Second, our process is based on an analysis of more than 50 years of macro and market cycles, with heterogenous decades. Patience means being prepared to weather a decade of odd backdrops and wait for historical averages to strike back. Our ‘40-40-20’ macro mantra struggled during 2010-2020 and then got rewarded. Patient investing requires flexibility and resisting the urge to rush all-in on a new trendy scenario, be it soft-landing, hard landing or Goldilocks. Such open-mindedness made it possible for us to catch the year-end rally in 2023, for instance. Sometimes patience is also about swimming against the tide: we are currently building an exposure to emerging assets, as we observe that risks could be retreating. 

It takes patience to be an active manager, and that patience is a long-term performance engine. 

(1) Past performance is not a guarantee of future results.

Didier Rabattu CIO, Equities

Pascal Menges CLIC® Equities, CIO Office

For long-term investors willing to look beyond cyclical patterns and focus on structural growth trends, the stock market could serve as a mechanism for transferring wealth from the impatient to the patient. 

Despite challenges such as rising interest rates, persistent inflation, a US banking crisis and ongoing geopolitical tensions, equity markets have demonstrated resilience and witnessed a significant rebound in 2023, defying recession-related predictions. Nevertheless, this market rally has been uneven, with significant variations across regions, market capitalisations and themes. Consequently, market anomalies have emerged, presenting asymmetrical opportunities where cyclical concerns are priced in while structural growth trends remain intact. In light of this, patient long-term investors could capitalise on current mispricing by engaging with active managers.

US and global stock indices are more concentrated than at any point in the past 30 years, meaning the number of ’effective’ stocks in the market has reached an all-time low. This suggests that passive solutions have become highly concentrated, and a broader equity rally can only be effectively captured by active managers able to deviate from traditional indices. 

For instance, small- and mid-cap stocks (SMID) are currently trading at nearly 20-year lows relative to larger capitalisations². Valuation discrepancies across industries and regions are at their highest levels since the late 1990s. Entire structural growth themes – such as wind and solar power, food and water value chains, transition materials, an ageing population and the digitalisation of finance (fintech) – present attractive investment opportunities. 

Patient investors prioritising a long-term perspective could leverage cyclical worries to their advantage.
 

(2) Source: LOIM analysis as of 31 January 2024.

Nicolas Mieszkalski Portfolio Manager

Alexey Medvedev Portfolio Manager

Patience has historically rewarded investors, as evidenced by the long-term performance trends of equity indices. Our approach seeks openings in areas exposed to the climate transition where stock valuations appear distorted and stand poised to benefit when pricing normalises.

High-emitting companies are already coming under increasing pressure from regulatory, market and technological forces – yet some of them will navigate the transition better than others, tap into new profit pools and potentially gain a larger market share. These high-emitters with credible plans to decarbonise present a solid opportunity set because hard-to-abate sectors, such as steel and cement, will nonetheless remain indispensable for the global economy. However, market valuations do not discriminate currently between decarbonisation leaders and laggards. Patient investors can find opportunities here.

Given ambitious net-zero targets are already in place for 2030 in the US and Europe, we believe that many companies we invest in have not yet reached their full potential but are on their way to doing so in the next five years. In the meantime, we seek to apply prudent risk management to minimise unintended risks while delivering the purest possible exposure to the net-zero transition. 

To read more on how our TargetNetZero equity strategy found resilience in 2023, please click here.

Sandro Croce CIO, Fixed Income

2023 was a good illustration of the rewards of being patient when investing in fixed income. Interest-rate volatility remained high – with rates grinding higher in the summer, followed by the historic recovery of the last two months. Investors may have lost patience holding fixed income in the first half of the year, penalised by the negative market effect, while the riskiest part of the credit spectrum outperformed thanks to attractive carry.

As we enter 2024, central banks are shifting from a hawkish to a more accommodative stance, with the first cut expected in the first half of the year. A bullish steepening seems the most likely curve trajectory from here, but it is better to be prepared for less-welcome scenarios.

Currently, rates appear attractive with spreads seeming tight, yet we believe positive macro data and dovish central banks justify valuations. From a total return perspective, rates and credit shouldn't be too dissimilar. With the curves still inverted, low investment grade (IG) spreads barely compensate, meaning that the carry offering in IG is effectively flat versus cash. However, simply staying in cash ignores reinvestment risk.

Given the wide range of potential scenarios, we believe the best approach is to remain invested and diversified, but use currently cheap credit protection opportunities to hedge against tail-risk events. We favour investing across duration and credit with a prudent move down the credit-risk spectrum, while remaining ready to act tactically and take advantage of opportunities as they arise.

Dhiraj Bajaj CIO, Asia Fixed Income and Equities

It was a volatile year for government bonds and credit spreads in 2023. Still, USD-denominated global fixed income and Asian emerging market (EMs) benchmarks outperformed USD cash returns even if all of the fixed income returns came in the last two months of the year. History tells us that approximately 80% of S&P 500 returns are made during 20% of the time periods during the past 70 years. The exact timings are largely unpredictable.

Fixed income markets will likely continue to experience these non-linear return trends over the next one to three years, in our view. We have a low conviction in the timing and pace of rate cuts in 2024, but a much higher conviction of the three-year pathway and the destination of the Federal Reserve’s neutral rate. This would then drive everything in our universe including dollar strength, the shape of the US Treasury yield curve, the rate cycle across Asia and EM, and credit spreads. 

We expect only a gradual US interest-rate normalisation cycle of 200 bps from H2 2024 to mid-2026, moving down from 5.5% to approximately 3.5%. This pathway over the next three years would allow for strong cumulative returns for EMs and Asia as they generally benefit from this tailwind, as well as regional growth, disinflation, lower fiscal deficits and domestic rate cuts.  Setting USD-based portfolios at 6-10% YTW³ from investment grade to high yield, and largely leaving them alone until 2026 is a good starting point for total returns based on income and capital gains. 

Patient investors will be in a good position to find better value. 

Discover our three-part series on the outlook for Asian credit here.

(3) YTW stands for yield to worst. Yields are subject to change and can vary over time. There is no guarantee that the return objective will be achieved.

Laurent Joué Head of Systematic Alternatives and Lead Portfolio Manager

Marc Pellaud, PhD Lead Portfolio Manager

The transition to a low-carbon economy represents an enduring trend that is likely to support new technologies and the commodities needed to build them. Patient investors could reap the rewards of long-term shifts and recurring cycles in the supply and demand of various raw materials that are exposed to the transition, in our view.

Significant systemic change will remain elusive without a substantial increase in the volume of these materials, as they are the fundamental building blocks of the transition. Events such as the Russia-Ukraine war exposed the vulnerabilities of depending on fossil fuels and highlighted the need for energy security – these geopolitical factors are likely to further accelerate government commitments to sustainable energy.

In our perspective, capital expenditure in the raw materials pertaining to the transition, such as mining companies, has been sub-optimal. We anticipate that supply will struggle to meet demand, resulting in the repricing of commodities linked to the transition. 

Current market prices have yet to reflect the potential risks associated with supply constraints on these commodities, and any shortage could bolster prices in the near to medium term. Furthermore, we anticipate prices will rally in metals and materials once the major central banks adopt a more accommodative monetary policy stance. 

For the patient investor, we believe exposure to a liquid, diverse and well-balanced portfolio of raw materials linked to the transition could offer superior prospects.

Peter Pulkkinen Portfolio Manager

Rhys Marsh Portfolio Manager

Private-market strategies offer patient investors access to less-correlated opportunity sets in exchange for reduced secondary liquidity. By committing to strategies ranging from early-stage equity, real assets and secured lending, investors may seek attractive returns across a greater spectrum of assets. Accessing such opportunities requires developing relationships with skilled off-market companies while being cognisant of investor priorities. 

We believe private credit is well-suited to deliver compelling risk-adjusted returns – particularly for climate-solution providers operating within fragmented, less efficiently financed markets. For such owner-operator-manager-led businesses, elevated interest rates, capital pressure and the retrenchment of traditional bank lenders create demand for solution-based, tailored liquidity that requires patient, stable investor capital. 
 

Compelling access

Direct lending is estimated to represent about 50% of the USD 1.5 trillion private-credit market. Loans to financial sponsor-controlled businesses, typically those owned by private-equity firms, represent nearly 80% of the combined European and North American direct-lending market. But sponsored businesses represent less than 10% of the 250,000-plus private firms within those geographies. 

The select opportunities in our pipeline tend to be sourced from patient relationships with non-sponsored firms. Operating where we see limited competitive tension, particularly within inefficiently financed distributed assets, presents a universe of deal flow less correlated to broader market trends. Delivering all-weather, senior-secured credit capital typically requires a flexible, solutions-based approach. 

As a seventh generation, privately owned business, Lombard Odier is privileged to partner with visionary climate entrepreneurs. Providing lower cost capital and skilled execution, cutting-edge sustainability research and stewardship underpin our aim of generating profit with purpose. 

None of this can be achieved without patience.

Christopher Tritten Global Head of Private Assets and Co-Lead Portfolio Manager

Victoire Carous Senior Investment Manager and Co-Lead, Plastic Circularity Strategy

Private equity investors can take a long-term view and, with patience, capture the benefits of the gradual and inevitable transition being undertaken by the plastic value chain.

The undeniable problems of plastic waste show that our linear model of production, usage and disposal is not sustainable. A shift towards circularity, in which sustainable materials and recycling play significant roles, is essential. But progress in developing recycling infrastructure and sustainable alternatives has been slow. And even though new models of consumption are emerging, such as zero-waste consumer products, changing behaviour takes time. 

As a result, policy makers around the world have started introducing laws and regulations to curb plastic pollution and promote recycling. Furthermore, brands have made significant commitments to incorporate recycled content into packaging by 2030.

The transition to a circular model is no longer a question of ‘if’ but ‘when’. This is why it is crucial to invest with a long-term view in new solutions. Private markets provide opportunities to invest in companies whose solutions have the potential to not only help solve the plastic waste problem but also provide outsized returns for investors. 

In contrast, it can be challenging for listed companies facing quarterly earnings scrutiny to focus on such a long-term shift. In the future, they may need to make acquisitions to catch up with the transition.

By investing with conviction and patience over a 10-year horizon, we can capture the long-term shift to circularity – and the value created by solutions driving this sustainable model. 

Christophe Khaw CIO, 1798 Platform

Unless you are perfectly timing the market bottom, most investment opportunities that promise attractive risk-reward dynamics don't materialise overnight. The ability to stay committed to your investment strategy depends on your conviction, the size of your stake, how you manage risks and the potential reward.
 
For example, we often find ourselves drawn to credit decompression trades when spreads are hovering near historic lows. However, we ensure we have the flexibility to increase our position when spreads hit those lows. This approach allows us to maintain a strong convexity profile with minimal carry, enabling us to hold on to positions for extended periods with relatively little volatility until our investment thesis plays out.
 
This emphasis on structural convexity is a core aspect of our investment philosophy in LOIM’s 1798 boutique.

Credit has been appealing for investors because of the overall yield given by the new rates environment. With the lack of issuance, bonds have rallied and compressed spreads – sometimes to 30-year lows. While we don’t forecast a steep recession, holding a short credit-spread position yields attractive risk-reward potential and one that is very uncorrelated to being long assets.

Morten Rossé Head of Nature and Climate, holistiQ

“A society grows great when old men plant trees in whose shade they know they shall never sit.”

The Greek proverb has never been more relevant. Put simply, there is no net zero without nature and the pace of nature is patient.
 
We believe that nature is a significantly undervalued asset class. The demand for climate-resilient, nature-positive land could drive the biggest asset revaluation of the century. Nature-based real assets are investments that transform degraded or under-used land into climate-resilient ecosystems that produce high-quality commodities in harmony with nature.

A transition to nature-based assets will:

• Turn degraded landscapes into regenerative assets that potentially appreciate in value over time
• Achieve a higher price for the commodities produced, as nature becomes essential to consumers and corporate climate mitigation strategies   
• Create diversified, resilient financial capital
• Safeguard nature’s essential ecosystems services
   

As conventional commodity production systems face climate and policy risks, demand for nature-based assets will outstrip supply, driving a vast asset revaluation, in our view. With this value premium realisable through established property markets, nature-based real assets are set to become a new form of real estate. 

For investors, an actively managed real-asset strategy offers myriad benefits, including risk-adjusted returns, portfolio diversification, low correlation with other asset classes, a hedge against inflation, and exposure to the emerging ‘nature premium’, as regulations create new opportunities to drive value while restoring our natural world. 

A nature strategy requires patient capital. But for those willing to invest for the long term, nature is our most reliable partner.

Arnaud Gernath Co-Head of Convertible Bonds

Convertible bond investors tend to be patient. The asset class has historically performed best if held for a full market cycle and typically delivers more attractive Sharpe Ratios over a longer term horizon⁴. Given time, the multiple performance drivers of the asset class can play their part, including coupon income, upside equity participation, bond floor protection and the pull to par at maturity for out-of-the-money positions where the equity has suffered a temporary drawdown. 

The convertible universe is continually renewed through issuance, which adds diversity and convexity. Convertibles are often the borrowing vehicle of choice for growth sectors, but timing when certain themes – such as artificial intelligence, biotechnology and renewables – will generate performance can be challenging. By acting as a bridge between the fixed income and the equity worlds, convertible bonds can provide positive yield and equity upside potential for investors patient enough to wait for these convictions to pay off. The asset class tends to have greater exposure to mid-sized issuers than the main global equity indices, therefore if the relative valuation gap between mid- and mega-cap stocks contracts, it could also generate gains for convertibles. 

Meanwhile in China, fiscal stimulus could lead to more positive sentiment and, consequently, the return of foreign capital. This could reward investors through the convexity of convertibles in the broader Asia-Pacific region. Buy and maintain convertible bond portfolios are an excellent way to generate potential returns for patient investors. They focus on locking in yield and keeping positions long enough for the underlying shares to rally, providing significant potential yield pick-up at final maturity.

(4)    Past performance is not a guarantee of future returns.