In a constantly changing world, it can be challenging for investors to maintain their focus on long-term trends and opportunities. Fidelity International’s Ilga Haubelt, Head of Equities, Europe, met with Andrew McCaffery, Global Co-Chief Investment Officer for Fixed Income, Multi and Private Assets, and portfolio managers Caroline Shaw and Kris Atkinson to discuss the secular themes that could shape the financial landscape well into the future.
“Valuations in small and mid-cap equities are at levels we haven’t seen in a long time.”
When investment markets go through extended periods of uncertainty, it’s difficult for investors to avoid looking for the next near-term bump in the road rather than focus on the horizon. The world can feel like it’s in a constant state of transition – geopolitically, industrially, and technologically – the pace of which presents us with an operating framework that is increasingly multi-faceted.
For instance, the geopolitical backdrop can generate short-term headlines but has also created scenarios that will likely play out for years. “This is now a multi-polar world, with different drivers, such as onshoring, friendshoring, and the deglobalisation of supply chains, competing for their place on the front pages,” says Haubelt. She adds that emerging markets could benefit from these developments, but the landscape may still be marked by higher inflation and capital expenditure.
As investors, the challenge is to discern the underlying trends and be positioned to tap into the long-term opportunities those themes may offer. Perhaps the most prominent of these is the acceleration of climate change and the accompanying task of building a more sustainable global economy.
Climate risk balanced by developing opportunities
It is apparent now that the impacts of climate change are coming at us far faster than expected. “Investors do face some hazards,” says Atkinson. These include corporate transition challenges, as industries are forced to shift to new business models more quickly than expected. There are also the physical risks that manifest in extreme weather events and their impact on supply chains or insurance payouts. “At Fidelity, we try to understand threats and opportunities, assess how they are priced and where they are insufficiently reflected in asset valuations.”
One of the key opportunities is in the build-out of renewable energy infrastructure as economies attempt to transition away from fossil fuels. Between now and 2050, an estimated USD21 trillion will be needed to install the renewable capacity required to get the energy grid to net zero, including about nine million kilometres of transmission network.1 “We focus on companies designing and manufacturing those elements critical to the grid upgrade,” says Shaw. “There’s also the need to build climate resilience into the grid, so we are looking not just at cabling and transmission parts but also smart-grid infrastructure.”
Indeed, considerable increases in power generation are integral to another secular trend: artificial intelligence (AI).
AI: Beyond the near-term noise
Amid the high valuations and elevated market noise that surround AI, it’s easy to forget that, in essence, we are looking at something as ‘simple’ as a data-processing tool. This tool offers promising long-term opportunities, including in sectors that don’t often make the headlines, like utilities. For instance, the US alone will need to add a forecast 250 terawatt-hours of power generating capacity over the next five years – equivalent to the entire present capacity of Spain – just to run data centres.2 This feeds into the power infrastructure investment theme.
AI's so-called “second derivative” wave also draws us towards industrial automation. “When we look at the available research, AI applications in the manufacturing sector have potential compound annual growth well above market rates; it’s a sizeable opportunity set,” says Haubelt. This means supply chain optimisation, predictive systems monitoring, customised production, and the prospect of digital twinning – this is where a digital version of a factory floor can be created, allowing any changes or upgrades to be tested before being implemented in the real world.
However, McCaffery warns that the market’s enthusiasm could be dampened over the next year as investors assess the realities of harnessing AI’s potential. “Many people still believe that there will be a significant payoff from AI, but this may be within an unachievable time period, largely because certain companies have still to achieve a significant productivity shift,” he says.
The attractions of smaller companies and fixed income
"Valuations in small and mid-cap equities are at levels we haven’t seen in a long time," says Haubelt. "Interestingly, that’s happening across geographies, with many of these stocks appearing inexpensive versus history and the market." Elsewhere, Haubelt says she is considering more defensive holdings and maybe even property-related names that have been somewhat overlooked.
In fixed income, Atkinson says the “attractions are at the front end of the curve, where the risk-adjusted returns look excellent, as opposed to the long end, where valuations are compressed.” From a longer-term perspective, fixed income technicals also look positive. “Yields are high, we’re starting from a good point, and the long-term secular trends suggest fixed income as an important place for a significant asset allocation,” he concludes.
Sources
1 BloombergNEF
2 Fidelity International
