Luke Dixon
2022 could look a lot like 2021 as once again we start the New Year amid a Covid-19 surge. Luckily, whilst the Omicron variant spreads easily, the illness itself appears less severe for those that are vaccinated. Resistance to renewed restrictive measures will likely mean that businesses are able to stay open in some form, so the economic effects of Covid-19 are likely to be less severe in 2022 baring the emergence of a new, more virulent and dangerous strain of the virus.
Given the similarities between this year and last, it will not surprise you that some of our headline predictions are repeated. Inflation has been dominating headlines in recent months and will remain a concern throughout 2022 as both demand and supply issues contribute to rising prices on everything from energy and housing to food and clothing. Climate change remains the hottest topic within Environmental, Social and Governance circles but we expect the conversation to broaden with more time given to diversity and inclusion initiatives this year. Finally, it seems a perennial concern for those on a fixed income or in need of regular cash flows: where can we find some yield in 2022?
- Inflation: Real Assets & Bitcoin
As the second half of 2021 unfolded our prediction that inflation could return proved correct. The combination of monetary easing, supply chain interruptions and staff shortages – all ultimately related to Covid-19 (and exacerbated by Brexit in the UK) – has resulted in an inflation spike around the world.
At first, most bank regulators and pundits believed that the inflation spike would be transitory and as workers returned to factories and drivers to their trucks, supply chain bottlenecks would ease, and inflation would return to trend. This, unfortunately, ignored the persistent staff shortages associated with Covid track & trace isolation orders and the effects of new Covid variants. The reality, for the foreseeable future at least, is that we are going to have to live with Covid and the effects of policies intended to minimise the impact of the virus and to sustain our healthcare systems. And once prices and wages tick up, they seldom “return to trend.”
So, with inflation expected to stay with us for some time, it’s important to consider seeking shelter in assets that ought to prove resilient to its dilutive effects. Real assets have long featured in institutional portfolios for their defensive characteristics – hard asset collateral, inelastic supply, monopolistic companies and essential industries and services. Importantly, lease terms for property assets frequently contain periodic uplifts linked to inflation, to ensure that landlords are not detrimentally impacted by the corrosive effects of inflation on the purchasing power of their rents. As a result real estate and infrastructure assets will be in demand this year.
Bitcoin and other cryptocurrencies remain a hot topic this year, with their ever-present price volatility attributed variously to government bans (China), government adoption (El Salvador), high energy intensity (i.e., poor climate credentials), and the musings of Elon Musk. There is one broad consensus, however, and that is that the structurally limited supply of Bitcoins should underpin its place as an effective “store of value” in the face of inflation.
Central governments can print money to fund asset purchase programs that support bond markets and suppress interest rates. This printing of money (increasing the supply of money) ultimately lowers its value, which means more of the currency is needed to buy a fixed basket of goods or services. That is the very definition of inflation.
A large part of Bitcoin’s appeal is its independence from government and its structural limit of 21m coins – more Bitcoins cannot be created at the whim of a government. More and more investors, including some institutions, are now allocating a small part of their portfolios to Bitcoin and other cryptocurrencies as both a way to protect their portfolios against inflation and tap into this high growth area.
- ESG: climate change, diversity and inclusion, and social equality
According to private equity giant KKR, the energy transition – the shift from a fossil fuel-based power system to a renewable and sustainable energy system – is expected to require USD 1.5-2 trillion per year for the foreseeable future. Opportunities related to the energy transition – such as renewable energy generation, industrial de-carbonization and electric vehicles – are not new for 2022 and will be multi-decade in nature.
On the back of race-driven social unrest in the US over the past several years, the spotlight has shone brightly on inequality in the workplace and in broader society. A variety of initiatives have been started with the aim of expanding opportunities for young people from disadvantaged backgrounds and for increasing the diversity of corporate boards and company management teams.
It is increasingly accepted that greater diversity and inclusivity improves decision-making and stakeholder outcomes because broader perspectives and experiences are included in deliberations. We wholeheartedly support such initiatives and investors are increasingly supporting companies that back their pledges with clear policies and demonstrable actions. Although we expect climate-related issues to dominate, we predict that broader ESG considerations will inform investment decision-making in 2022.
- Search for yield: low interest rates spur demand for alternative credit and real estate
Interest rates have been at or near all-time lows throughout the western world for most of the past decade so the search for yield is not a new idea. What has been shifting materially over the past few years are institutional allocations to private credit and direct lending as a replacement for traditional corporate credit. This is because higher yields can be found in private credit, as well as better downside protection in the form of restrictive and protective covenants than can be found in the syndicated lending and corporate bond markets. And with interest rates likely to rise from these historic lows as central banks seek to curb inflation, we expect to see a pickup in demand for floating rate credit such as real estate loans from investors and for more flexible financing solutions from borrowers.
As mentioned in our section on inflation, the inflation-linked leases (rents) associated with real estate will also be attractive in a rising inflation, rising rate environment. We expect investor demand for real estate and private credit solutions to accelerate in 2022.
Summary
We are excited by the investment prospects for 2022 but perceive the risks to economic growth as being higher in 2022 than in 2021. We are concerned about the persistence of inflation and wary of the social and economic impacts of new and virulent strains of coronavirus emerging in the months ahead as societies resist a return to stringent lock-down measures.
Yet we are optimistic that innovations in technology and healthcare can keep us productively working and healthy this year. There are lots of exciting investment opportunities in front of us and we are excited to roll these out to you throughout 2022.
