Transcription

• Disclaimer

  This podcast is only for the attention of professional investors in the financial industry. Outer Blue by Amundi. Welcome to Outer Blue Talks Research. Knowledge sharing on financial research.

• Swaha Pattanaik

  Hello and welcome to this Amundi podcast with me, Swaha Pattanaik. Today, we're taking a step back from the short-term market swings and looking at what the coming years and indeed decades might hold for investors based on the findings of our newly published Capital Markets Assumption Report. In case you haven't come across it before, our Capital Markets Assumptions or CMA report is an annual overview that gives you expected returns across various asset classes and a range of time horizons going out as far as 30 years, which I think covers most of our needs. Our aim is to give long-term investors a framework to think about portfolio construction, which is becoming all the more difficult perhaps in a world that feels more fragmented, more uncertain, and more unstable. Here, to discuss all of this, it's my pleasure to welcome the heads of the two teams that have worked on this pretty hefty piece of research. Monica Defend, head of the Amundi Investment Institute. Hello, Monica.

• John O'Toole

  Hello, Swaha. Thank you.

• Swaha Pattanaik

  And John O'Toole, Amundi's global head and CIO of Solutions. Great to have you on the podcast, John.

• John O'Toole

  Hi, Swaha. Thank you.

• Swaha Pattanaik

  So the title of this year's Capital Market Assumptions Report is Adapting to Ruptures. Now, rupture is a pretty dramatic word and probably needs some context. After all, it feels like we've been cycling through a series of crises since, I don't know, stretching probably back to 2008 at least. Monica, perhaps I could turn to you first to ask you to run us through some... concrete examples of why you think we're at a real watershed moment now and not just going through yet another big shock to the system.

• Monica Defend

  Yes, thank you. Actually, it was quite a straightforward choose. The word ruptures really encaptures what the world investors are facing now. We're no longer in an environment where shocks, as you were mentioning, are temporary deviations from a stable trend, but the rupture is becoming part of the trend itself. Think about geopolitical fragmentation, strategic competition, the rewiring of supply chains, the delayed energy transition, demographics, fiscal dominance, and the artificial intelligence race. They are not isolated events. They are forces that are reshaping the economic and financial regime. So, the key message we have for you in this CMA edition is very simple. Adaptation is no longer a defensive exercise. It is a new source of resilience and performance. And for investors, this means broad market exposure is not enough anymore. The next decade will reward those who can distinguish between regions, sectors, currencies, public and private markets. and who can build portfolios able to live with more persistent disorder.

• Swaha Pattanaik

  Thanks, Monica. John, anything to add?

• John O'Toole

  Yeah, I mean, as Monica says, it's not just going to be enough to have a broad market exposure. In terms of portfolio construction and responding to the new realities that we face, selectivity is always important. But to build portfolios that incorporate resilience is going to require flexibility and breadth of asset class exposure. One feature I would say going forward is currency considerations are really becoming more relevant and important. The same global portfolio can look very, very different compared to the base currency, especially in euro-yen investors. And if we look at recent history, the last 12 months, the euro has performed plus 6% or so versus the dollar. While in contrast, the yen has weakened by 7.5% or so. And while we do expect the dollar to weaken gradually over the long term, it's really been... a continuing path that we think that the dollar has fallen by about 13% since its peak in 2022, which was a two-decade high. It's only fallen 2% the last year or so, but we expect that that trend will continue, albeit we're not calling for a sudden collapse. So currency is really going to be an important feature and a way for the stresses and strains of the world to become reflected.

• Swaha Pattanaik

  Okay. Thanks, John. So Monica, let me go back to some of the big themes. John was just talking about sort of the big currency view that you have going forward. You were talking about some other big themes, demographics, artificial intelligence, and also the report looks a lot at strategic autonomy. Some of these are some of the long-term forces that investors should be watching closely. How did these three factors shape the macro views in this year's CMA? And what are some of the differences compared with last year's edition?

• Monica Defend

  Yeah, well, these three forces are central because they define, as you said, the medium term regime. And this is important because this year in particular, the CMA is not only about the very long term, but it is more about our adaptation over the next one, three, five years will shape the longer-term equilibrium because countries are adapting, are making choices that needs to be implemented and the next one, three, five years will be crucial. So, in a national our macro view is that growth will remain resilient but not exuberant. Artificial intelligence can support productivity, fiscal spending. can support demand, but demographics, fragmentation and energy constraints are really powerful breaks. So, we do not see a collapse in growth, but we also do not see a return to the old comfortable world of low inflation, low rates and unlimited globalization. Inflation is likely to be more persistent than in the pre-pandemic decade beyond the current environment where we see really a difficulty in convergence towards the central bank's target. But it is not necessarily permanently high, but definitely it will show an higher floor. So energy security, climate adaptation, defense, industrial policy and supply chain resilience will all have a cost because strategic autonomy, and this is not something peculiar to Europe. It is something that is happening around the globe. Strategic autonomy is not for free. And the difference versus the previous CMA editions is that we are moving from a world driven mainly by cyclical adjustment to a world driven by structural investment needs. So if you want, the question is less when does the cycle turn, but more who adapts better to the new regime and this is exactly where investors should focus.

• Swaha Pattanaik

  Thanks, Monica. So, John, perhaps you could give us a helicopter view. We will drill down into details, but if you could start off with a broad overview of how this is all filtering through to your views on expected returns.

• John O'Toole

  Yes, thanks. Well, I mean, long-term expected returns across most asset classes, I would say they're fairly appealing. We've upgraded bonds slightly. They're looking more attractive compared to the last year's CMA because yields are higher. Equities are offering potential solid returns somewhere between 6.5%, 7.5%. Now, returns are more uneven across regions. Credit, on the other hand, is less compelling than before because spreads are quite a bit tighter than they have been. Gold and FX, as we've mentioned, they will matter more than they used to, and they're really becoming more strategic part of any portfolio design. So, you know, overall, we do emphasize selectivity, diversification and resilience.

• Monica Defend

  Can I add something on this, because we've been discussing with you at length this aspect. Really, our expected returns this year are resilient, not because the world is less risky, but they are resilient because the starting point for investors is much better than it was a few years ago. For a long time, investors were living in a world of suppressed yields, expensive assets, very little compensation for risk. Today, the risk-free rate has been rebuilt. Bonds offer income again. Equity still benefits from nominal growth, innovation and productivity potential. And we will see that later on. But the message is not that ruptures are positive. The message is that ruptures create a more demanding but also a richer opportunity set. Let's bring you an example, AI. In optimistic pathways, AI can raise productivity and support margins, but even in more complex scenarios, the investment linked to artificial intelligence, data centers, power grids, semis, creates opportunities. beyond the technology stocks. And the key distinction is this. Expected returns are not resilient because risk disappears. They are resilient because investors are finally being paid again to allocate capital. But selectivity becomes crucial.

• Swaha Pattanaik

  As John mentioned before, absolutely. So, John... The bonds focus is really interesting in this report. You mentioned earlier the starting point for yields is higher. I mean, what else is going on to drive sort of this slight upgrade that you mentioned on the bond side?

• John O'Toole

  But bond yields, if we compare it to last year, for example, in Europe, Yields are up about 60 basis points in the 10-year part of the curve, but 100 basis points in the shorter term. Two-year yields in Germany are 100 basis points higher than they were. Japan, plus 70 over two-year. UK, plus 60 over two-year. Interestingly, the US is pretty unchanged, actually. 4% for two-year bonds, 4.5% for 10-year. That's pretty much in the middle of the range that we've seen, between 4% and 5%. And really, just back up in yields, it's obviously providing a more meaningful income. It helps to diversify portfolios and does act as a kind of a shock absorber when markets become volatile even though the volatility that we've seen has been very episodic and frankly given all the new slow we've had, you know people may be surprised at where markets are trading, but it's all of this is a big change from the ultra low yield period that we had you know about pre-COVID and you know the backup in yields obviously is reflecting the rate complex it's reflecting fiscal, it's reflected balance sheets, it's reflecting long-term concerns about funding. But given a relatively benign backdrop that we see in terms of growth and inflation in the very long term, these yield levels in portfolio construction terms will provide that kind of resilience that we spoke about.

• Swaha Pattanaik

  Thanks, John. Monica, anything on the bond side that you wanted to pick up on?

• Monica Defend

  Oh, yes, please, because... There is just a few messages I wanted to convey and share. So the big change that we are seeing is that bonds have eventually recovered their role. So in a zero rate financial environment, bonds often look like, you know, insurance with no income. But today they can again provide carry, diversification and a potential shock absorber when markets become volatile. which... Again, we should not be naive. This is not the old bond environment. Fixed income investors now need to think much more carefully about fiscal dominance, larger debt supply, term premium, and domestic demand for sovereign debt. So, government bonds are attractive, but the fiscal story matters today much more than before. And our message on bonds is income is back, but discipline. is back too. And we like the role of government bonds and investment grade credit in portfolios, especially for moderate risk investors, as you will hear in the publication. But we also need to be selective across curves, countries and credit quality. So, it is not anymore a matter of chasing yield. The new world environment is about being paid for risk without ignoring the sovereign and fiscal constraints behind that yield.

• Swaha Pattanaik

  Got it.

• John O'Toole

  If I may add to that, I mean, as Monica says, credit spreads are very tight and this concept of investors being paid for risk and investors are being paid less and less for taking extra credit risk, for example, in both investment grade and high yield. So, we would say the easy gains are likely behind us. So, this importance of selectivity is huge. Investment grade spreads in Europe are very tight to below 60 basis points. Kind of trading at their 200 day moving average is precisely the same pattern in US investment grade, US high yield about, yeah. 300 basis points, lower end of the range, European high yield, just below 300 basis points. And again, these reflect, if we look at these kind of figures in the longer term, we're not quite heading back to pre-COVID low tides, but we're not too far away.

• Swaha Pattanaik

  OK. So, I mean, the words that keep coming up so far are selectivity, discipline. John, you mentioned expected returns for equities were looking pretty decent. I presume the selectivity message also applies to equities.

• John O'Toole

  It absolutely does. But I mean, if we look at the overall expected returns across the equity piece, it's really reasonably narrow, I'd say between six and a half, 7%. I mean, at the upper end of that, we would say emerging markets offer an overall attractive appeal, expected return for the whole emerging complex around 7%, just over 7%, driven really by places like India, which were very positive on for the structural growth story. I mean, again, this s a very long-term story, but we're penciling in a 7.5% return. But also, in developed markets, Japan, there's a huge amount of reform happening in the governance and capital efficiency shareholder returns. So we penciled in Japanese equity expected to return of just under 7%. In Europe, again, for different reasons, the industrial renewal, the AI deployment, the strategic autonomy that Monica has referenced. Again, European equity returns just over 7%. So, pretty bunched up. And the US for us, really, obviously it remains extremely important. But given valuations and given the super high concentration risk, structurally, we do see some bigger concerns there. So, we're penciling in a 6.5% return reflecting those concerns. So, really, it's in quite a narrow band, but I would say that these equity returns are pretty appealing for a long-term investor. Okay,

• Swaha Pattanaik

  Thank you. John, you John mentioned just now the concentration risks in the US. I mean, that's obviously related to AI-associated trades. Monica, how is this affecting your view in the macro outlook and expected returns, the whole AI sort of topic?

• Monica Defend

  Yes, thank you, Swaha. Well, AI is one of the most powerful forces in this story, but I think we really need to be precise because AI is not. not a kind of a magic wand that removes all macro constraints, because AI can support productivity, can help offsetting part of the demographic drag and create new sources of growth. But at the same time, it also creates investment pressure because data centers, chips, power capacity, grids, cooling system, they all require massive capital expenditure. And this can support a growth on one side, but it can also add pressure on energy demand, infrastructure and inflation on the other side. The second point that I would like to make is that AI will not benefit everyone equally. Think about the US and China, they are leading the frontier model race. Europe may benefit more through deployment, industrial applications. and productivity diffusions. And for investors, this means that AI is not only a technology sector story, it is more an economy-wide real location story. And the real question is not only who builds the model, it is also who owns the infrastructure, who has the energy, who controls the data, who can deploy AI into real industrial processes. We expect Japan to do that and to lead on that and whose business model gets hollowed too. So AI increases potential returns but it also increases dispersion and this will definitely create winners but also expose vulnerabilities for investors. That means that AI is not a theme just to buy blindly but it is more a lens through which you can and you have to reprise sectors, regions and also business models.

• Swaha Pattanaik

  Thank you, Monica. So, John, I mean, you're looking at this very practically, multi-asset solutions, all of these things. How are you looking at this when you're advising long-term investors on the AI topic?

• John O'Toole

  The AI topic, it's fascinating. It's unknowable, I would say, what the outcome will be. I was I think a good proxy for this is we think back to the internet and the evolution of the internet and the iPhone and think of all the companies that didn't exist 20 years ago, Google, Meta, etc., which ended up creating new jobs and new industries effectively that did not exist 20, 25 years ago. So the productivity gains that will likely come from this phenomenon, I think it can really drive global growth in a positive direction. If the resilience of the system, we will see who the winners and losers are. But governments, I believe, will have a role in, you know, they want activity that's taxable. They want and will need employment as well. So there are a lot of absolutes going around about the AI phenomenon. AI will beget AI, AIs will build better AIs, and they themselves will build better AIs. So I just think we're in the foothills of this phenomenon and our understanding of it, but I think it can have huge productivity benefits.

• Swaha Pattanaik

  Thank you. Maybe they'll need humans to bring them cups of tea or something. We'll see what our world is in the future. More immediately though, you both over the past, I don't know, 18 months, nearly two years, have been flagging the importance of gold and including gold in portfolios. You've done this in the Global Investment Views where you give your monthly convictions and the outlook. What sort of place does gold have in long-term portfolios when you do the CMA sort of exercise? Monica, perhaps I'll start with you.

• Monica Defend

  Yes, actually, this is a new entry in the universe we cover with the CMA. And the reason is that gold has become more and more relevant because it has moved from being a crisis hedge to being really a strategic asset. And the reason is that the demand for gold is becoming more structural. The central banks are diversifying the reserves. Investors are reassessing geopolitical risk, fiscal risk, currency risk. And in a world where the correlation between stocks and bonds may be less reliable than in the past, gold can really contribute to the portfolio resilience. And of course, I'm not saying that gold is a perfect asset because it does not generate income. Its volatility is meaningful, we should not really oversell it, but its role in portfolios, I think, has dramatically changed. And in my view, gold is really increasingly a confidence hedge. It is not only protection against inflation or crisis. It is a protection against a system where investors question the stability of currencies, fiscal trajectories and geopolitical alignment. Tn the CMA space, gold deserves a more strategic place and not a tactical panic trade, but a part of the long-term portfolio diversification.

• Swaha Pattanaik

  OK, thanks, Monica. And John, perhaps private assets are also featuring, not the first time necessarily, but in the CMA report as having a really important place when you're looking at long-term portfolio constructions. What sort of place does the CMA think it should have?

• John O'Toole

  I mean, absolutely. It speaks to the theme that we mentioned, breadth of asset class, breadth of exposure, choice, flexibility, adaptability. And certainly in the private asset sphere, it is a way to allocate capital to phenomena and markets that behave differently from public markets. And if we think about the themes that we're talking about, more structural themes like energy transition, security needs, digitalization, then for sure this speaks to infrastructure spend and infrastructure build. You know investors can take access to that theme and again we pencil in a return of you know just below eight percent for infrastructure assets and again that's outperforming public equities for example and if we think about private equity we believe strong returns again uh in the order of nine plus percent in between Europe and US again versus public equity range of six and a half separate. So you're getting this kind of substantial pickup in return expectations. Similarly, in private debt, you get a very attractive carry. And again, you're picking up close to 2%. We expect, so 5% for private credit versus 3 and a bit for public credit. And lastly, real estate, again, in an income-led recovery, logistics, industrial spend and focus. Again, globally, we think returning 5, 5.5%. and again outperforming high yield credit and yeah high yield credit as well so four or five percent so we think it's an appealing complex and again it behaves differently. It plays a different role in the cycle to public markets and it should be in everybody's strategic toolkit and again it's important to say you know about private assets are not necessarily liquid assets but for long-term investors and particularly in the concept of retirement. You know, retirement assets do not need to have daily liquidity. So, we strongly believe that there is a strong case for inclusion of private assets in such portfolios.

• Swaha Pattanaik

  Thank you, John. That makes complete sense. So, we have covered a lot of ground, Monica. John, do you perhaps want to leave our listeners with one key takeaway very quickly? Monica, perhaps you first.

• Monica Defend

  Well, my takeaway would be that investors should not... look at the CMA as a forecast exercise only. It is, as you were mentioning at the beginning, Swaha, it's really a portfolio construction roadmap across different regimes because we are not living in a simple world, but policy, geopolitics, technology, climate are interacting in ways that make the investment landscape more unstable, but also more differentiated. So the challenge is not to predict every rupture. I wish, but we can't. And the challenge is really to build portfolios that can adapt when ruptures happen. And this is really the spirit of this report. Do not wait for the old world to come back, but build for the world that is emerging. And for long-term investors, resilience and performance will increasingly come from the same place. Selectivity, diversification, real income, structural themes, and the ability to adapt.

• Swaha Pattanaik

  John,you have the harder task of going second.

• John O'Toole

  Yeah, I mean, look, it plays to the same themes. I would say structurally, you know, the productivity gains that we expect to come from technology, that can really drive global growth in a positive direction and a different quality of growth. And the resilience and robustness of markets is better if we compare it to pre-global financial crisis. You know, we have stronger systemic guardrails in place around capital positions of banks, for example. and overall leverage in the financial system, the way leverage is deployed. Against that, you have the debt load of the world and the fiscal space and issues that we have in government balance sheets. But again, the growth dynamic and the productivity of that, the efficiency of that can counterbalance. So again, as Monica says, it's not a forecasting exercise, but I think it does provide us a decent frame and a window to think about returns. And as we say, the returns look pretty appealing and allow investors to construct robust and resilient and well-diversified portfolios.

• Swaha Pattanaik

  John, Monica, thank you both for joining us and explaining a very complex subject so clearly.

• Monica Defend

  Thank you, Swaha.

• John O'Toole

  Thanks very much, Swaha.

• Swaha Pattanaik

  And thank you for tuning in to this Amundi podcast. If you're interested in digging a bit deeper into the ideas we've been discussing, Check out the full CMA report on the Amundi Research Centre. We also have some very cool interactive graphics produced by our data visualisation editor, which allow you to change your base currency, time horizons and play around to your heart's content. Whether you do play with it or not, we hope you enjoyed the podcast and that you will join us again soon.

• Disclaimer

  2014-65-EU, dated 15 May 2014, as amended from time to time on markets and financial instruments, called MIFID II. Views are those of the author and not necessarily Amundi Asset Management SAS. They are subject to change and should not be relied upon as investment advice, as a security recommendation, or as an indication of trading for any Amundi products or any other security, fund units, or services. Past performance is not a guarantee or indicative of future results.