Panorama - Investing in 2021
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Panorama
For marketing purposes
For global professional /
qualified / institutional clients
and investors and US retail
clients and investors.
Investing in 2021 | UBS Asset Management
Reframing the future
06
| 14
| 22
| 40
|
The road Dividends for The trends Seizing
back to yield-thirsty suppressing Artificial
normal investors bond yields Intelligence
opportunities
In this edition of Panorama, our
senior asset class and allocation Contents
experts assess the potential
challenges and opportunities 3 Change? Or more of the same…
investors face in what continues Reflections on 2020
to be a low rate environment.
6 The road back to normal
The following pages offer distinct Macroeconomic overview focusing on the ramifications
viewpoints and investment insights of the US election and investment ideas for 2021
across our global capabilities, to help as the search for yield continues
meet your investment challenges.
14 Dividends for yield-thirsty investors
For additional content and A look at defensive dividend strategies as a
previous editions of Panorama, potential source of income
including videos and additional
in-depth investment insight, 18 Are small caps taking big strides?
visit ubs.com/panorama With the long-term growth potential of smaller
or scan the below QR code. companies, will this see bigger opportunities
for investors?
Panorama
For marketing purposes
22 The trends suppressing bond yields
For global professional /
qualified / institutional clients
and investors and US retail
clients and investors.
In a low rate world, are attractive yields
Mid-Year 2020 | UBS Asset Management
within reach if we look to Asia?
26 Turning to hedge funds for yield
The key structural opportunities we see in 2021
for hedge fund investors looking for yield
Investing in a new landscape
06 18 26 32 28 The income challenge
Plotting Crash to Eight reasons Is ESG
the path recovery – to stay invested rebalancing?
to recovery what's next? in EM/China
With interest rates at record lows, can diversified
multi-asset portfolios meet the income challenge?
32 Infrastructure spending reviving the economy?
With trillions of dollars of investment required globally,
infrastructure looks well positioned to deliver a
long-term income stream for investors
36 Driving sustainable outcomes
Publishing information: Panorama is released Will the new passage of EU regulation lead to improved
bi-annually by UBS Asset Management investor returns and redirect investment towards
Editorial deadline: November 2020
sustainable investing?
Editor-in-chief: Claire Evans
40 Seizing AI opportunities
Editors: Sarah Gill, Lavonne Kuykendall Special focus on the barriers and challenges to the
and Spencer Sheehan
adoption of artificial intelligence in fundamental analysis
Production manager: Kaleigh Griffin
47 Why UBS Asset Management
Design: Kelly McLaughlin
ubs.com/panorama
Barry Gill
Head of Investments
more to entrench existing trends than
to invert them. It proved an accelerant
on internet disruption, which served
to exacerbate well-entrenched service
industry disinflation. And this in turn
heavily influenced global bond yields
which are currently plumbing previously
unimaginable lows.
Change? While we have clearly experienced a
profound recession and an accompany-
Or more of
ing bear market, from an investor’s
perspective it has felt very different to
prior economic downturns in that the
impacts have been so lopsided. Many
the same… companies are on their knees, but some
parts of the economy have actually
never had it better, leading to incredible
dispersion in equity returns and credit
spreads. And the rebounding equity
As 2020 draws to a close, and we turn market should remind us all that stock
our focus to the upcoming investing valuation is as much about the discount
year, it is tempting to be biased by rate as it is about earnings.
recent experience and assume that
shock and volatility are here to stay; But with world equity indices back
this is part of the human condition. within reach of record highs and
government bond yields below 1% in
But when one parses this year it actually every major economy other than China,
becomes clear that the virus and the the challenge to outrun liability growth
associated economic lockdowns did is greater than ever for many of our
clients, particularly those who have
annual obligations. How to generate
Many companies are on their knees, income in a world bereft of yield is
but some parts of the economy the primary focus of this edition of
Panorama: Investing in 2021, and we
have actually never had it better, lean on several of our internal experts
leading to incredible dispersion in
equity returns and credit spreads.
3
We shed some light on another that dynamic by allocating into private
markets, something that is backed up
probable outcome of the current by our Real Estate & Private Markets
team as they explore the opportunities
low yield environment, that the available from infrastructure investing.
We believe that infrastructure should be
traditional diversification benefits a prime beneficiary of the economic
stimulus packages and low interest rate
across the asset classes will likely environment spurred by the pandemic.
break down. Elsewhere, we explore the potential
ramifications of the US election, the out-
to look at this challenge from a variety look for small caps, and the limitations
of perspectives and to consider the of artificial intelligence for fundamental
opportunities across asset classes. analysis. And we round it all off with
an examination of the sweeping EU
Our Fixed Income portfolio managers regulation on sustainability-related
encourage our clients to seek yield by disclosures.
adding exposure to Asia and China in
particular, while our Quant team points I hope you find our year-end update
to high dividend opportunities in the both informative and provocative.
equity markets. The CIO of O’Connor Please don’t hesitate to contact your
discusses why the timing is right to UBS Asset Management partner should
allocate into multi-strategy hedge funds, you seek further insight.
particularly as an income substitute.
We look forward to our continued
We shed some light on another partnership with clients throughout the
probable outcome of the current low next year.
yield environment, that the traditional
diversification benefits across the asset
classes will likely break down, with
views from our Multi Asset team. They
make the case for seeking to improve on
4
The road back
to normal
2021 investment trends
2020 was the year of the pandemic, instant recession,
and US election drama, while we think 2021 is
poised to be the year of vaccines and a more durable,
comprehensive economic reopening.
Evan Brown
Head of Macro
Asset Allocation With the election behind us and a economic recovery is poised to continue
Strategy
potential response to the pandemic in and become more self-sustaining as
sight, we expect the nascent economic medical innovations allow for the
expansion to gain traction amid normalization of private-sector activity.
continued policy support and increased
visibility towards the development of an Real interest rates are negative across
effective and broadly available vaccine, advanced economies, and are likely to
which should also foster a decline from stay that way through 2021 and beyond.
Ryan Primmer the extreme levels of market volatility We believe a less aggressive outlook for
Head of Investment that prevailed in 2020. While these US fiscal stimulus limits the prospect of
Solutions developments will likely be positive for a sudden, significant rise in Treasury
risk assets, the medium-term outlook yields that would have spillovers across
for generating reliable, meaningful yield international markets. Investors will have
has never been more challenging. to work harder to generate yield.
The challenge for income generation The appeal of opportunities in multi-
We believe that the overall macro asset hedge funds and alternative assets
environment is highly supportive of risk could increase in this low-yield-for-
Lucas Kawa
Asset Allocation assets, and we have a bias towards longer environment. Within the publicly
Strategist procyclical relative value positions. The traded universe, the progression of the
6
Exhibit 1: Optimistic vaccine scenario provides upside risk to divided government growth outlook
Biden + Divded Congress Optimistic vaccine 2019 level
24
23
22
Trillions (USD)
21
20
19
Dec '19 Mar '20 Jun '20 Sep '20 Dec '20 Mar '21 Jun '21 Sep '21 Dec '21 Mar '22 Jun '22 Sep '22 Dec '22
Source: UBS Asset Management, UBS Investment Bank, Macrobond, BEA. Data as of 10 November 2020.
Gray line represents 2019 US Gross Domestic Product as baseline.
7
Exhibit 2: Attractive yield pick-up available in Chinese bonds, US dollar-denominated EM debt
JPMorgan EMBI Global Spread China 10-year bond yield
7.0%
6.5
6.0
5.5
5.0
Percent (%)
4.5
4.0
3.5
3.0
2.5
2.0
Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug
'15 '16 '16 '16 '16 '17 '17 '17 '17 '18 '18 '18 '18 '19 '19 '19 '19 '20 '20 '20
Source: UBS Asset Management, Bloomberg. Data as of 10 November 2020.
global economic expansion coupled of higher taxes has lessened consider- emerging market assets is our highest
with the low level of yields on devel- ably, removing one potential headwind conviction view, which is bolstered by
oped-market sovereign debt should to US earnings growth. the election results.
likely push investors up the risk spec-
trum. In our view, this makes emerging In our view, this election outcome will The virus and vaccines
market dollar-denominated debt, help foster sustained US dollar weak- COVID-19 remains a persistent risk that
including Chinese government bonds, ness, with the protectionism premium threatens to delay the timing and
particularly compelling. embedded in the world’s reserve magnitude of the economic recovery,
currency ebbing in light of this change particularly in the near term. However,
US election impact in leadership. We expect the Treasury we foresee the impact of additional
The results of the US election provide curve to steepen over time as the waves of the pandemic on activity to
increased clarity on the economic expansion makes further headway. play out in the form of mini-cycles.
outlook. President-elect Joe Biden is
likely to take office with a Republican But the potential for ongoing, substan- More adaptive public behavior, better
Senate. This combination should provide tial fiscal stimulus stateside has dimin- health practices, and less draconian
the US economy with adequate ished materially, reducing the odds of a restrictions on activity may mitigate how
additional fiscal support, though not as disorderly rise in bond yields that could much rising case counts weigh on the
much as would have been the case in foster dollar strength. Linked to this economic mobility. We think that the
the event of a united Democrat outlook for a softer US dollar, the success of these measures in curtailing
government. In addition, the likelihood across-the-board outperformance of the spread of the virus will avoid the
type of prolonged retreats in activity
8
The broad-based economic recovery is
conducive to the outperformance of
emerging markets. So too is the relative
status of China’s economic comeback,
which is in a more advanced phase
than any other nation.
seen earlier this year and allow the therapeutics and advances in testing We prefer US small caps to their large
normalization process to resume more constitute upside risks that could allow cap counterparts, which are more
expediently. for a swifter, broader normalization of sensitive to the unfolding domestic
activity. The myriad logistical issues that recovery buoyed by progress towards
We expect regulators to potentially could delay the distribution and a vaccine that facilitates a durable
approve three vaccines for COVID-19 administration phases of vaccination reopening. Third quarter earnings
before year-end. Recently we have seen serve as downside risks. results showed that expectations run
highly encouraging phase three trial high for stay-at-home beneficiaries
results from these prominent candi- Even as this process reaches its ad- in the equity market, and we believe
dates. This increases our conviction in vanced stages, we would still expect that the degree of improvement in
economic normalization occurring over high-contact portions of the services operating performance in 2020 is
the course of 2021, and reduces left tail industry, including tourism, to operate unlikely to be matched next year.
scenarios in which a medical break- well below pre-pandemic levels of
through remains elusive for an extended capacity. This is why targeted fiscal Europe’s sounder foundation
period. support will still be needed to cushion Europe is in the midst of a seasonal
the ongoing income stress faced by wave of COVID-19 that has caused
By mid-2021, we expect a material share afflicted households and businesses politicians to reimpose mobility
of the population across advanced during a drawn-out adjustment process. restrictions across many nations. This
economies to be inoculated. For most disruption to the near-term growth
emerging markets, this process is likely outlook is well understood and largely
to take longer. The development of priced in, in our view.
9
We prefer non-US developed
market equities, which have more
cyclical exposure.
Going forward, we believe Ireland is a of premature fiscal and monetary boon for the global market outlook in
good leading indicator of the improve- tightening that suppressed the recovery general, and for emerging markets as
ments in the virus outlook we expect from the global financial crisis, and in well as other procyclical assets in
across the continent. New case growth turn, political tail risks. particular.
is declining, the lagged effect of govern-
ment restrictions on activity that were While a step down from 2020, Beyond the aforementioned attractive-
enacted before other European European budget deficits are slated to ness of dollar-denominated debt in
countries. This pattern is indicative of be larger in 2021 than at any time in light of current spreads, we also favor
the COVID-19 mini-cycle thesis outlined the post-2009 recovery. emerging market currencies, which have
previously. outsized catch-up potential relative to
Emerging strength other procyclical trades.
We prefer non-US developed market The broad-based economic recovery is
equities, which have more cyclical conducive to the outperformance of
exposure. This view is in part informed emerging markets. So too is the relative
by the sea change in European counter- status of China’s economic comeback,
cyclical policy relative to a decade ago. which is in a more advanced phase than
The common shock spurred higher any other nation. The resilience in the
cohesion between European Union world’s engine of production and strong
member states, reducing the prospect credit impulse may continue to bolster
global activity, as long as growth in total
social financing, imports, and invento-
ries does not moderate too briskly. In
our view, this positive influence is a
10Overall signal =
Negative Positive
Exhibit 3: Traditional asset classes, and currencies—as of 6 November 20201
Overall
signal Unattractive Neutral Attractive
Japan
UK US Eurozone
Equities
Switzerland Australia China
EM ex China
UK US
US Inflation-linked
Fixed Income EZ (Core) Switzerland EZ (Non-core) China sovereign
Australia
Japan EMD LC
US Inv Grade
EU Inv Grade EMD USD
Credit
EU High Yield Asia credit
US High Yield
USD GBP
EUR
EM Asia ex-China CHF
Currencies Latin America JPY
CAD CEEMA
Nordic
AUD CNY
1
Source: UBS Asset Management’s Investment Solutions Macro Asset Allocation Strategy team as at 6 November 2020. Views are provided on the basis
of a 3–12 month investment horizon, are not necessarily reflective of actual portfolio positioning and are subject to change.
11Thoughts from our key investment experts 12
How should investors prepare for uncertain
markets ahead?
In an era of lower-for-longer, our portfolio managers
share their insights on what 2021 could bring from
an income/yield perspective.
13Equity income
Dividends
for yield-thirsty
investors
The search for reliable sources of income
For income-seekers, life has become an investment
challenge. As yields on decent quality bonds languish,
can defensive dividend strategies offer attractive
alternative income sources?
Patrick
Zimmermann
Head of Quantitative In a world of low interest rates and Nonetheless, there are three potential
Investments years of asset purchases by central sources of equity income: dividends,
banks that have led to ultra-low bond share buybacks and call overlay
yields, many yield hunters have turned strategies, and we assess their place in
their attention to equities where equity income portfolios.
dividend yields have remained broadly
in line with their historical norms of The income investor’s toolkit
Urs Raebsamen 2% to 4%. In the years following the Global
Head of Investment Financial Crisis (GFC), many companies
Specialists,
Systematic & Index
While equities offer the potential to deleveraged and bolstered their balance
Investments participate in the market’s upside, there sheets by building up significant cash
is also the risk of capital loss larger than reserves. The COVID-19 crisis led some
what a typical high-grade fixed income of those companies, most prominently
investor might be willing to accept. a number of UK-listed banks, to cut or
14Many yield hunters have turned their
attention to equities where dividend yields
have remained broadly in line with their
historical norms of 2% to 4%.
Exhibit 4: Equity dividend yield in line with historical average in Europe and US
Current (%) 10-year average (%) Current (%) 10-year average (%)
8% 8%
Europe US
6 6
4 4
Percent (%)
Percent (%)
2 2
0 0
-2 -2
European Euro Euro German German US US US US US
Dividend Corp Bond Corp Bond 10yr 3M Dividend Corp Corp 10yr Bond 3M
Yield IG HY Bund FIBOR Yield Bond IG Bond HY Yield Rates
Source: FactSet, as at 30 September 2020.
15even cancel their dividends. Many firms,
however, have kept their dividends Many firms the P/E will fall. To preserve the compa-
ny’s intrinsic valuation, the share price
intact, and yields held up well when
markets fell. As markets recovered
have kept their should rise to keep the P/E broadly in
line with its pre-buyback level. This
strongly, yields have come down
somewhat.
dividends intact, effect is otherwise known as ‘the
buyback yield’ – the long-term price
To identify stocks with sustainable
and yields held increase due to share buybacks.
dividends, we favor a combination of up well when Buyback volumes in the US peaked
high dividend and high quality stock before the COVID-19 equity market
selection criteria; the latter of which can markets fell. correction and have since dropped
be measured by looking at metrics such significantly. While earnings have also
as high profitability, low financial Another means by which equities have fallen, US companies have on average
leverage, strong corporate governance delivered meaningful income returns in been cautious and many have raised
and human capital management, stock recent years has been through the use capital in the bond market to enhance
price stability and size, amongst others. of share buybacks. By buying back their liquidity position. With the
We believe this combination of dividend shares, companies reduce the number economy as well as earnings recovering,
and quality criteria can lead to better of shares in circulation, distributing cumulative cash balances are approach-
results over the long term. profits over a smaller pool of shares. ing peak levels again and we believe
This is reflected in higher earnings per that this should allow companies to
share (EPS). resume buyback programs.
Unless there has been a dramatic (and
coincidental) change in fundamentals,
if the EPS rises, so should the share
price – if the share price doesn’t rise,
16Exhibit 5: US companies’ cash balance over time
Cash
14%
12
10
% of total assets
8
6
4
2
0
'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 YTD '20
Source: UBS US Equity & Derivatives Strategy/Bloomberg, as of 30 September 2020.
Income from option overlays times of market distress, selling call Therefore, we believe equities offer yield
Covered call overwriting strategies options usually provides greater levels of hunters a multi-faceted investment
systematically sell short-dated call income during turbulent bear markets. approach – dividends, share buybacks
options on portfolio holdings. The call and call overlay strategies – to generate
option seller earns an option premium, During the COVID-19 market correction, income. Given that the three sources are
which itself adds an income stream to option premia rose significantly, complementary with respect to their
the portfolio, but with the added allowing us to achieve roughly double behavior in different parts of the cycle,
benefit that by selling call options on a the normal income and at the same a combination of all three approaches
stock, the portfolio’s market sensitivity, time setting the strike-levels much could prove an effective means of
and therefore downside risk, contributes higher whereby upside participation in navigating 2021 to achieve the income
to a smoother return profile. In ex- a rebound increases correspondingly. investors are seeking.
change for the income and the added
layer of downside cushion, the call
overlay will reduce the portfolio’s upside We believe equities offer yield
participation.
hunters a multi-faceted investment
The call option premium is a function of
the portfolio’s implied volatility. The approach – dividends, share buybacks
higher the level of implied volatility, the
higher the premium that can be earned
and call overlay strategies – to
from selling optionality. Given that levels
of volatility are generally higher during
generate income.
17Small Cap
Are small caps
taking big strides?
Resilience during periods of economic stress
Small-cap stocks have historically led the market
coming out of a recession, so can investors expect
bigger opportunities from smaller companies in
the year ahead?
Viara Thompson
Research Analyst,
Pan-European Small Small cap stocks underperformed large Why invest in small caps?
& Mid Cap Equities cap stocks in the turbulent period According to Bloomberg, there are on
around COVID-19.1 This reaction is in average four sell side analysts per
line with the last global market correc- company covering small caps vs. an
tion in 2008 when small caps dropped average 16 analysts per large cap. This
further than large caps and rebounded could provide well-resourced portfolio
more strongly in the recovery (Exhibit 6). management teams with a substantial
Over the long term smaller companies information advantage and enable them
David W. Sullivan have provided better returns and over a to identify attractive investment
Investment Analyst,
US Small Cap 20-year period the MSCI All Country opportunities.
Growth Equities Small Cap index outperformed the
MSCI All Country World index by 2.3%2 Small cap indices are less concentrated
per annum. than large cap indices, with the largest
10 stocks in the MSCI ACWI Small Cap
As markets and economies enter Index representing only 2.0% of the
recovery post COVID-19, we believe it index’s total market cap, while the top
is an opportune time for investors to 10 companies in the MSCI ACWI Index
consider increasing their commitment
Kevin Barker to small cap strategies.3
Head of Equity
Specialists
1
Source: MSCI as of 30 September 2020. Past performance is not indicative of future results.
2
Source: MSCI as of 30 September 2020. Past performance is not indicative of future results.
3
MSCI defines small caps as the companies at the bottom 14% by free float and excludes them from its standard indices.
18Exhibit 6: MSCI All Country World and MSCI All Country Small Cap (USD)
MSCI All Country World Small Cap MSCI All Country World
2,500
2,000
1,500
USD
1,000
500
0
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20
Source: Bloomberg LLC, MSCI. Data as of 30 September 2020.
19Small Cap
Exhibit 7: Relative performance of the median manager against benchmark
for five-year period ending 30 September 2020
2.5%
1.88
2.0
1.43
Outperformance (%)
1.5
1.0
0.61
0.5
0.0
-0.5
-0.71
-1.0
Pan-Europe Pan-Europe US Small US Large
Small Cap Large Cap Cap Equity Cap Equity
Equity (EUR) Equity (EUR) (USD) (USD)
Source: eVestment, as of 30 September 2020.
accounting for 15.7%.4 This means
that small cap managers typically have We believe it is an Small cap stocks also typically have a
higher beta. This greater cyclicality has
a higher active share than large cap
managers.
opportune time been a negative in 2020, but on a
longer-term basis the higher cyclicality
Exhibit 7 compares the performance of
for investors to and beta is a positive for delivering
better returns.
small cap and large cap investment
managers relative to their benchmarks
consider increasing Environmental, social and governance
in the US and Europe. Over the past five their commitment issues are of increasing importance to
years, the median small cap manager investors and data for smaller compa-
outperformed their benchmark by to small cap nies can often be more difficult to
nearly 1.9% in Europe and 0.6% in
the US, while the median large cap strategies. access due to the relatively low
coverage of these companies by data
manager outperformed their bench- providers but this may begin to change
mark by 1.4% in Europe and underper- Potential small cap investment with new regulation in 2021.
formed by 0.7%5 in the US. Hence, pitfalls
adding better manager performance Small cap indices often have a larger An attractive entry point
to higher overall returns increases weight in cyclical sectors such as Clearly, the current earnings environ-
the return that small cap investors Materials and Industrials, while large cap ment is very difficult for companies.
may realize over the long term. indices typically have a larger weight in This makes looking at short-term
Information Technology and Communi- metrics such as price/earnings (P/E)
cation Services. This is especially the ratios more challenging. The forward
case in the US and less so in Europe. P/E ratio of 21.7 for small caps against
4
Source: MSCI as of 30 September 2020.
5
Source: eVestment, as of 30 September 2020.
20a P/E of 19.2 for the MSCI ACWI As the level of public information on and extremely valuable in building
reflects the higher cyclicality of small companies is lower, knowledge sustainable long-term performance.
earnings for smaller companies and the built up by investors over a long period Hence, a manager with greater depth
depressed earnings delivered so far and through numerous interactions with of resources and experience may have
during the pandemic- management teams is hard to replicate a clear competitive advantage.
induced global recession. However, as
economies move into recovery phase
we should see the greater cyclicality Hence, adding better manager
lead to faster earnings growth, thereby
justifying the higher shorter-term performance to higher overall
P/E ratio.
returns increases the return that
We expect the current disruption to
accelerate certain structural changes in
small cap investors may realize over
how we work and consume. While a
few US mega caps are seen as benefi-
the long term.
ciaries of these changes, there are many
investment opportunities in small caps,
which are either niche champions or
more strongly exposed to structural
growth themes than their larger peers.
21Fixed income
The trends
suppressing bond
yields
Real yields remain attractive in Asia
For fixed income investors looking to enhance portfolio
returns, does Asia hold the key to finding income in a
low yield environment?
Charlotte The era of negative bond yields in policy tool for central bankers – now
Baenninger
developed markets has continued to active across the yield curve.
Head of Fixed
Income present challenges for fixed income
investors with approximately USD Although the Bank of Japan was the
15 trillion1 or the equivalent of 24% of first to enact yield curve control and
the investment grade fixed income set a zero percent target for 10-year
universe yields currently zero or below. Japanese Government Bonds (JGB) in
2016, other central banks such as the
A recent JPMorgan study also found Fed and the Reserve Bank of Australia
Hayden Briscoe that 76% of all developed market seem likely to do so albeit at the front
Head of Fixed sovereign bonds had a negative real end of the curve.
Income, Asia Pacific yield.2
Given the dramatic expansion of fiscal
Lower yields for longer policy across many developed markets,
The trend of ultra-low yields in devel- governments will need bond yields to
oped markets is likely to persist for three remain low and therefore bond purchas-
main reasons. Firstly, with developed es via quantitative easing to stimulate
market central bank policy rates at or economic growth seem likely for the
near the lower bound, longer-dated foreseeable future.
government bonds have become a
1
Source: Bloomberg, Bloomberg Barclays Global Aggregate Bond index as of 30th September 2020.
2
Source: https://www.bloomberg.com/news/articles/2020-10-08/jpmorgan-says-real-yields-are-negative-for-31-trillion-of-bonds
22Active fixed income investors can
pull on several levers such as interest
rate management, asset allocation
and security selection in an effort to
achieve attractive returns despite low
entry yields.
Secondly, central banks are trying to get Active fixed income investors can pull So with yields back down to sub-zero
more creative in moving inflation, and on several levers such as interest rate levels and income now scarce, where
inflation expectations, above target. If management, asset allocation and should investors be looking in their
successful, and if nominal yields are well security selection to achieve attractive search for yield in 2021?
anchored, then real yields (yields after returns despite low entry yields.
inflation) could move even lower.
The Fed recently indicated that it would Exhibit 8: GDP growth by region, 2020 vs 2021
hold rates at very low levels even as
prices start to rise to allow inflation to 2020 2021 (estimated)
run above target. We believe other 10%
developed market central banks will 6.9
likely follow. 5.2
5
3.1
Percent (%)
Central banks have committed to
0
buying corporate bonds and ETFs,
effectively crowding out private capital. -2.2
-5
While their interventions in corporate -4.3
bond markets have diminished recently, -8.3
their role as market makers of last resort -10
Asia Euro Area US
could continue. Additionally, ageing
populations in developed countries
mean increased savings and demand for Source: FactSet – as at 31 October 2020.
fixed income assets are driving yields
down even further.
23We believe pockets of opportunity exist We believe this presents an excellent attractive real yields, low correlation to
in emerging markets where only 17%3 investment opportunity as yields remain global markets and backing from one of
of sovereign bonds are negative yielding attractive; and investors may further the world’s few remaining net creditor
after adjusting for inflation. benefit from spread compression. nations. We believe this is a compelling
Asian high yield is also less exposed to risk-reward tradeoff.
Asia offers growth – and unrivalled commodities and consumer cyclicals
yield than European and US high yield. Chinese government bonds yields
In Asia many economies are already in troughed in 2Q20. However, China is
recovery mode, with China leading the China remains a standout now tightening credit expansion and
way. But looking deeper into Asia, China’s this, combined with a challenging
onshore bond market remains a outlook for the global economy, means
This is largely due to Asian countries standout opportunity, and particularly China’s rapid rate of growth may slow
pursuing a multi-tiered response, Chinese government bonds given the from mid-2021. We think further rate
including credit support, fiscal stimulus, cuts are likely in 2H20.
and well-designed pandemic response
measures. Asian govern- Focus on Asia for 2021
On the monetary policy side, Asian ments have been These segments of the rapidly-growing
Asian fixed income universe are just two
governments have been more reluctant
to cut rates − opening a substantial yield more reluctant to of many yield opportunities in Asia.
margin to take advantage of in Asian
high yield markets compared to Europe
cut rates. An Asia allocation can provide investors
exposure to a region poised to bounce
and the US. back in 2021, as well as strategic
long-term positioning as Asia evolves as
the world’s key growth driver.
3
Source: https://www.bloomberg.com/news/articles/2020-10-08/jpmorgan-says-real-yields-are-negative-for-31-trillion-of-bonds
24Exhibit 9: Nominal yields on 10-year sovereign debt, Aug 2010–Aug 2020
China USA Germany Japan UK Switzerland Australia
6%
5
4
3
Percent (%)
2
1
0
-1
-2
Aug '10 Aug '11 Aug '12 Aug '13 Aug '14 Aug '15 Aug '16 Aug '17 'Aug '18 Aug '19 Aug '20
Source: Bloomberg, As of end September 2020.
25O’Connor
Turning to hedge
funds for yield
Multi-strategy hedge funds as an income substitute
Market volatility has seen multi-strategy hedge funds
make a comeback this year, but how have these returns
been generated and what are the structural opportunities
for investors looking for yield?
Kevin Russell
Chief Investment Global financial markets are polarized. factors (common attributes of securities
Officer, O’Connor On one side are the optimists who see a that shape different return and risk
COVID-19 resolution as inevitable by the profiles), and interest rates as likely more
middle of 2021 and expect expansionary range-bound, albeit in a substantially
fiscal policy around the world. Discus- more volatile range than we have seen
sions among this cohort often transition in the years prior to 2020.
to the potential for value stocks to
outperform and inflation risks to Even as we contemplate the possibility
steepen yield curves in both the US and of inflationary pressures and higher
Eurozone. On the other side are the interest rates as we are reminded of the
“lower for longer” group, who see historically low nominal interest rate
structural headwinds to inflation and environment currently, we are focused
virus challenges extending well into on structuring our portfolio to thrive in
2022. This cohort continues to focus on a low interest rate environment. So,
secular growth names that benefit from when the inevitable questions come
a low interest rate environment. from investors on where to find income
for their portfolios, we are ready and
As is usually the case, we expect the real advise that alternatives can really deliver
answer here is somewhere in the middle in this regard.
of these bookends, and we see equities,
26Exhibit 10: Five-year trailing performances – equities and high yield
vs. volatility
Average 21D Volatility
Total return (%) (annualized) (%)
S&P 500 Index 72.0 14.5
Bloomberg Barclays US High Yield
Bond Index 35.6 3.7
Source: Bloomberg LLC. Data as of 30 October 2020.
Many alternatives strategies, especially which banks and broker-dealers have managed and that investors are being
absolute return strategies like had to retreat due to regulatory well compensated by getting additional
multi-strategy hedge funds, offer a risk pressures. carry and often credit enhancements
and return profile that more closely relative to more liquid credit strategies.
mirrors a credit or income strategy Two areas of potential yield Our expectation is that investors will
allocation like high yield bonds than it Two areas where we are seeing continue to increase their private credit
does equities. tremendous value and see as structural allocations over the next several years,
opportunities for investors looking for and we believe that the trade finance
This results from the broad construct yield are private credit and trade space will rapidly evolve through
with which hedge funds approach the finance. While there is inevitably a securitization and become a replace-
market: largely hedging beta, sector, trade-off in liquidity for investors and a ment for many investors looking for
and factor risk, and profiting from small trade-up in complexity, we have short duration income.
relative value discrepancies and conviction that those risks can be
inefficiencies in the global equity and
credit markets. Increasingly, we are
seeing investors recognize this fact and Two areas where we are seeing
request distributing share classes to
complete the yield replacement idea by tremendous value and see as
enabling the strategy to deliver current
income for investors. structural opportunities for investors
Additionally, the flexible mandates and
looking for yield are private credit
broader product capabilities that exist
among alternatives asset managers have
and trade finance.
allowed capital to be allocated to
segments of the credit markets from
27Multi-asset
The income
challenge
Ways to look for yield in multi-asset portfolios
Central banks have driven interest rates to record lows
in an effort to boost an economic recovery during the
pandemic. But can investors find answers to the search
for yield within diversified multi-asset portfolios in 2021?
Nicole Goldberger
Head of Growth
Portfolios,
Investment Solutions The multi-decade decline in bond simple, traditional portfolio structures to
yields across advanced economies has have lower volatility which in turn
cultivated a new conundrum for increases the geometric return.
investors: there is no longer such a
thing as a positive risk-free real return, With interest rates essentially at this
ex ante. As the desire for income lower bound, this relationship has the
generation has not waned, these potential to become less robust and
Lou Finney circumstances have meant it is necessary reliable over time. In the short run over
Co-Head of Strategic to think differently when looking at the the next few quarters, we expect the
Asset Allocation
Modeling investment offerings required to meet negative relationship of 2020 to persist.
these needs. As the economy continues to recover,
we believe that equity prices should
Adding to this challenge is the potential move upward and interest rates should
that government bonds will be hard- gradually increase. Conversely, should
pressed to deliver the same degree of another shock occur, we see US 10-year
diversification benefits seen in the past rates potentially declining all the way
two decades, in which they displayed a down to 0.2% and expect US long
Michele Gambera
Co-Head of Strategic robust negative correlation with equity bonds in particular to provide some type
Asset Allocation markets. This combination allowed for of hedge in sell-offs.
Modeling
28Exhibit 11: Stock-Bond Correlation of Nominal Total Returns
Rolling 36 Month Values: S&P 500 with US SBBI Long Gov
S&P 500 with US SBBI Long Gov Average 1 Average 2 Average 3
0.8
0.6
0.4
0.35
0.2
Correlation
0.0
-0.8
-0.2
-0.29
-0.4
-0.6
-0.8
-1.0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
Source: Morningstar Direct. Analysis by UBS Asset Mangement. Data as of August 2020.
A sustained acceleration in inflation that larly private markets if you are able to By and large, alternatives have delivered
pushes the stock-bond correlation into relax the liquidity constraint (and meet compelling risk-adjusted returns and can
positive territory is the biggest risk to the investor requirements of these help investors build better portfolios.
traditional portfolios that use bonds as private funds). Illiquid alternatives – pri- Private equity has median internal rates
their primary hedge against drawdowns vate equity, property, hedge funds and of return above public equities over the
in equities. infrastructure – provide not only long term; unlevered real estate looks to
diversification benefits, but can be be between stock and bonds; and
A more likely risk to portfolios is that structured to produce attractive, though private debt markets have IRRs slightly
the low level of US interest rates and variable, income.
proximity to the zero lower bound
results in a stock-bond correlation that
edges closer to zero, setting up a As the economy continues to recover,
situation in which this “safe” asset
provides neither meaningful yield nor we believe that equity prices should
sufficient diversification.
move upward and interest rates should
Alternative assets can provide
diversification gradually increase.
Today’s market realities highlight the
need for a more flexible multi-asset
mindset to capture higher income
opportunities. We recommend the
incorporation of alternative diversifiers
to build multi-asset portfolios, particu-
29Multi-asset
Exhibit 12: Dry powder (uncalled but committed capital), in USD bn
Dry powder
3,000
2,500
2,000
USD in billions
1,500
1,000
500
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: Preqin. Data for 2020 through September.
above high yield returns.1 While Real estate investments historically estate is that it can act as an inflation
alternatives are not immune to the have provided stable income returns hedge. Should inflation rise consistently
pressures of a low yield world, we over time, while also acting as a risk above 2%, we expect real estate to
expect their return premium relative to reducer in portfolios given their low perform well relative to other asset
other risk assets to persist going volatility and low correlations to classes.
forward. traditional asset classes. Consequently,
we expect steady returns in the mid-sin- Private infrastructure − income
Increased capital in private equity gle digits for unlevered property, with Private infrastructure has provided a
There is already a significant amount of the majority of the return coming from stable source of income, while it is also
capital flowing into private equity, income as well as modest capital prized for its low historical correlations
which covers a large number of appreciation. Another benefit of real to traditional markets. Infrastructure,
strategies and niche markets, broadly
broken into three categories: growth/
return-oriented strategies, debt Should inflation rise consistently above
strategies, and natural resource
strategies. Public pension plans, 2%, we expect real estate to perform
endowments and sovereign wealth
funds are expanding their allocations to well relative to other asset classes.
alternatives. Total dry powder – the
amount of uncalled, but committed
capital – is now over $2.5 trillion, up
over $1 trillion in the last four years.
1
Preqin database as of 31 December 2019.
30Exhibit 13: Risk and return: Historic and prospective2
Historic 10-yr UBS’s expected 5-yr
Performance (%) Performance (%)3
Public assets
Global Equities-Unhedged 8.5 7.2
Global Aggregate IG Fixed Income-Hedged 3.9 0.2
US Cash 0.6 0.3
Alternatives
Private Equity US Private Equity 8.2
12.2
Global Private Equity 9.5
Global Real Estate Unlevered Property 9.7 5.8
Core Funds 10.8 6.2
Value-Added/Opportunistic Funds 14.1 6.7
Hedge Funds Low Volatility 4.0
3.6
High Volatility 4.7
Infrastructure Global Infrastructure 10.3 6.2
Notes: Propsective future returns for alternatives are net-of-fees and alpha. Fees: 1.7% for private equity, 0.9% to 1.1% for real estate, 1.0% for hedge
funds, 1.2% for infrastructure.
like private equity, is a cash flow element of government involvement After a torrid 1990s and 2000s, the
investment strategy, but there are because of the public nature of the returns of hedge funds in the 2010s
substantive differences in the type of investment. In a sense, they are a ‘low dipped into mid-single digits. We would
investment, payout period, and expect- beta’ private equity investment. expect similar modest future returns, but
ed performance that is distinguished their attractiveness as a diversifier and a
from ‘traditional’ private Given the demand for private infrastruc- source of asymmetric returns should
equity. Moreover, infrastructure is ture investments in a post COVID-19 remain. Well-constructed hedge fund
fundamentally different in they are world, we believe that this is an area portfolios have historically offered low
always physical, capital intensive that will likely remain resilient and beta exposure to equity and fixed
projects, not software or services. They attractive to investors moving forward. income markets and consequently
have large up-front capital costs, longer deserve strong consideration in
but steadier payout periods, and an portfolios.
2
Source of historic returns: Global Equites from MSCI ACWI Index unhedged in USD terms (through September 2020). Global bonds from Bloomberg
Barclays Global Aggregate Index hedged in USD terms (through September 2020). Cash from FTSE 1-Month US Treasury Bills (through Sept 2020) PE
from Cambridge Associates (through March 2020). Unlevered property from NCREIF Property Index (through June 2020). Core funds from NCREIF Fund
ODCE Index (through June 2020). Hedge funds from HFRI Fund Weighted Composite (through Sept 2020). Infrastrucure from average of median IRRs
from Preqin database for 2008-2017 period.
3
We develop 5-year expected returns in the capital markets based on current markets and our expectations of inflation, growth and the path of interest
rates. We then overlay our assessment of fair value and the reversion and how quickly the market will react. From here we extrapolate to the different
sectors of the capital markets.
31Infrastructure
Infrastructure
spending reviving
the economy?
Investible universe continues to grow
With vast amounts of infrastructure spending expected in
the next 20 years, will the private infrastructure sector
see a surge in popularity?
Declan O’Brien
Head of Infrastruc- The pandemic and volatility in global desired long-term income stream for
ture Research and stock markets this year has driven investors, particularly with trillions of
Strategy
interest rates lower, and highlighted the dollars of investment required globally
need for investors to diversify in search in infrastructure projects.
of high-yielding assets that can provide
a stable source of income. The relative stability of infrastructure
investments has become particularly
Despite the extraordinary circumstances appealing during times of public market
Alex Leung of 2020, the private infrastructure volatility. In addition, extreme weather
Analyst, Research &
Strategy Infrastruc- industry did not skip a beat. In the first events have highlighted the need for
ture (North America, nine months of the year, the industry low-cost and reliable clean energy,
Asia) raised USD 74 billion (see Exhibit 14), especially since the economics of
which may lead to a record year. With renewables continue to improve (see
the infrastructure universe growing Exhibit 15 on page 34). In contrast,
globally, we believe that the asset class commodity price volatility has weighed
looks well positioned to deliver the on the fossil fuels industry.
32The asset class looks well positioned to
deliver the desired long-term income
stream for investors, particularly with
trillions of dollars of investment required
globally in infrastructure projects.
Exhibit 14: Private infrastructure on track for near-record fundraising year
No. of funds Capital raised (USD bn)
140
120
100
USD (billions)
80
60
40
20
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Oct 2020
Source: Preqin, November 2020.
33Infrastructure
Exhibit 15: Renewables and batteries have become cost competitive
2010 2019
1,200
1,000
800
Cost (USD)
600
400
200
0
Nuclear Coal Wind (Offshore) Gas Solar Wind (Onshore) Battery (pack price)
Source: Bloomberg, Lazard Levelized Cost of Energy Analysis 13.0, October 2020.
Note: Levelized Cost of Energy (LCOE) (USD/MWh) for renewables; pack price (USD/KWh) for battery
The current economic crisis has provided energy efficient buildings, and other In the US, President-elect Joe Biden’s
a rare opportunity for countries to hit environmentally-friendly technologies. policies could help boost green infra-
the reset button, and reprioritize their This presents vast opportunities given structure investments. His USD 2 trillion
long-term development goals. Infra- the scale of investment needed. climate plan promises to invest across
structure spending is a tried-and-true green transportation, electricity and
way to alleviate unemployment and The EU recognizes that the public sector building sectors, while creating millions
kick-start stagnant economies. But cannot bear the entire burden of of new jobs. However, if Republicans
unlike past infrastructure stimulus decarbonization and will use a budget retain control of the Senate after the
packages, the next wave of investments guarantee to allow the European January runoff elections, they will likely
will likely have a greater emphasis on Investment Bank (EIB) and other push back on these plans. We believe
addressing environmental, social and partners to invest in higher-risk projects investors can still remain cautiously
sustainability issues. while “crowding in” private investors. optimistic, as there is actually more
For example, the EUR 1 trillion European
Green Deal Investment Plan has now Infrastructure spending is the
taken on even greater importance, not
only as a way to tackle climate change, tried-and-true way to alleviate
but also to revive local economies. The
EU’s action plan is for Europe to be unemployment and kick-start
climate neutral by 2050 by investing
across green energy, transportation,
stagnant economies.
34Telecommunication is another sector
that has received significant attention
during the pandemic. High speed
internet has enabled working-from-
home and remote-learning.
bipartisan support for renewable energy high speed internet, and have essentially Looking ahead, it is clear to us that the
than what the headlines suggest. For been deprived of these essential services mega-trends of energy transition and
example, red states such as Texas and during lockdowns. digital transformation are here to stay,
Oklahoma actually have the largest and that infrastructure is an ideal way
wind power capacity in the US, while In a recent poll by the Internet Innova- to gain exposure to these long-term
swing states such as Arizona and tion Alliance, 90% of respondents themes. The private Infrastructure indus-
Nevada boast the highest solar power support Congress using federal funds to try, equipped with over USD 200 billion
potential. There are incentives for both expand broadband internet network of cash reserves, will likely play a
parties to reach a consensus. infrastructure to areas that currently do significant role in the next wave of
not have access, and 88% support infrastructure investments.
Telecommunication is another sector Congress increasing support to those
that has received significant attention who cannot currently afford broadband
during the pandemic. High speed internet. The next wave of telecommu-
internet has enabled working-from- nication infrastructure investments
home and remote-learning. However, will therefore need to address the
rural areas and low-income neighbor- current digital divide across different
hoods generally have poor access to communities.
35Sustainable Investing
Driving sustainable
outcomes
Increased regulation could present opportunities
How is the regulatory landscape set to change over the
coming months and what do those changes imply for the
allocation of capital?
Susan Hudson
Head of Regulatory Will regulation shape the sustainable investing agenda?
Management
Susan Hudson
Sustainability risks are increasingly We expect capital allocated towards
viewed by asset managers, investors those companies best placed to
and regulators as a potential source of transition to a long-term sustainable
financial risk. This is why we have seen future, and away from those less
some asset managers integrate environ- able to do so, will most likely deliver
Michael Baldinger mental, social and governance (ESG) improved returns.
Head of Sustainable considerations into their investment
and Impact Investing
processes, not least to meet the The regulatory landscape
requirements of clients who also To respond to the threats posed by
recognize the financial and other sustainability risks, governments and
benefits of sustainable investing (SI). national regulators are focused on
establishing frameworks and disclosure
As a large-scale asset manager, we standards for the financial sector to
believe that the capital markets will take sustainability into account in
ultimately help address these challenges. investment decisions.
36Governments are focused on
establishing frameworks and disclosure
standards for the financial sector to
take sustainability into account in
investment decisions.
The United Nations has taken the Sustainable investment in the EU Today all firms in the EU are free to
lead with the United Nations Paris But it is the European Union that is the define sustainable investments as they
Agreement adopted on 16 November first jurisdiction to make a major start in see fit. But from March 10, 2021,
2016, and agreed by 125 countries, setting out new guidelines. investment firms will be required to
including the UN 2030 agenda for classify their offerings according to
sustainable development. Adopted by In 2018, under the Action Plan on whether and how they incorporate
193 countries, this is a wider agenda Financing Sustainable Growth, the sustainability based on new standards
than climate change and is also focused EU launched a 10-point program to published last November in the Sustain-
on economic, social and environmental reorient capital flows, impose require- able Finance Disclosure Regulation
development. ments on financial institutions to take (SFDR).
sustainability risks into account and
Other initiatives include the Financial encourage companies to disclose more For certain products, classified under
Stability Board’s task force on climate information on sustainability on the Article 8 and 9 of the SFDR, investment
related financial risks, the UN Principles basis of effective metrics and a long- firms must explain how environmental
for Responsible Investment, and steps term view. or social characteristics are promoted
taken by the UK and France on steward- or investment in sustainable activities is
ship and ‘comply or explain’ principles The EU wants to encourage investment achieved.
which encourage companies to increase in sustainable activities and the new
disclosure. It is clear that governments disclosure regime is intended to increase Initially, this disclosure will be high-level
are becoming increasingly serious about transparency and give investors the and principles based but will be further
tackling this issue and Hong Kong, ability to compare products and enhanced once the SFDR Regulatory
Singapore, Germany, Switzerland, Spain, sustainability outcomes. Technical Standards are in force and
Canada and the US are all examining new rules requiring corporations to
this topic more closely. disclose more non-financial information
37on sustainable activities are introduced. – Data companies will strive to bridge According to a survey conducted by the
Currently, we expect these develop- the gap by mapping their existing Board of the International Organization
ments from 2022. data points to the EU requirements. of Securities Commissions (IOSCO, April
– As more data becomes available from 2020), there are more than 12 initiatives
Key break out points corporations, the disclosure of currently underway across the globe on
– Investment firms marketing ESG sustainable characteristics and reporting principles and frameworks.
products in the EU will need to report activities is intended to become a
on sustainable investment using EU comparable metric for certain Fragmentation remains a risk in the
categorizations and definitions. products. near term with more clarity and
– Investment firms will engage with – It remains to be seen how other alignment needed. In April 2020, IOSCO
companies to request better informa- jurisdictions will use the work done in decided to establish a Sustainability
tion on sustainable activities. the EU to inform their thinking. Task Force with a mandate to promote
transparency and investor protection,
including “decision useful” disclosures.
Investment firms must explain how
This will be welcomed by issuers,
environmental or social characteristics investors and regulators and will help
are promoted or investment in drive a level playing field over time.
sustainable activities is achieved.
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