Asia’s significance will rise as global growth remains solid for the next decade. While China looks inward for domestic consumption and cleans up its act through green investments, Southeast Asian economies will benefit from the global supply chain migration out of China.
This is according to Pictet Wealth Management’s 2021 edition of Horizon, its 10-year view on economies, expected returns and strategic asset allocation. Launched in 2014, Horizon is published annually.
Asia’s economic importance will likely become even more significant in the current decade, says Dong Chen, senior Asia economist at Pictet Wealth Management, the wealth management arm of the Geneva-based Pictet Group, with CHF662 billion ($977.32 billion) in assets under management.
In 2019, Asia accounted for 34.8% of world GDP, up from 26.9% in 2009. Between 2009 and 2019, over half of global economic growth was attributable to Asia. “We expect Asia’s (ex-Japan) annual GDP to grow at 4.2% by 2031 and account for an even greater share of world GDP over the next 10 years,” adds Chen.
For the first time, Pictet has extended its 10-year analysis to Chinese assets including the renminbi, Chinese sovereign bonds and equities. This pivot in focus comes as major western currencies are expected to deliver negative real returns after inflation over the next decade, notes Pictet.
“Chinese assets have become unavoidable and are set to become an important source of returns for multi-asset portfolios and our strategic asset allocation,” writes Pictet’s chief investment officer César Pérez Ruiz. “Their inclusion is a natural response to China’s place in the world economy and its status as the sole real challenger to the US’s technological and economic leadership.”
China’s economic transition
Chen, co-author of the report by Pictet’s asset allocation and macro research team, notes that as China’s economic structure shifts, it will be less reliant on physical capital and fixed-asset investment — especially government investment — and more on household consumption and services.
The world’s number two economy has been steadily refining its climate goals, and its latest plans outline carbon neutrality by 2060 after hitting a peak in emissions by 2030. “Weighing up the boost to growth from large scale investments in green technologies against the inevitable costs that will be incurred as the economy decarbonises, we believe climate change policies will provide a modest 10 bps boost to Chinese annual GDP growth to 4.8% from 2025 to 2030,” says Chen.
As China continues to register strong economic growth and progressively opens its financial markets, it makes “increasing sense” to consider Chinese assets for inclusion in strategic asset allocations, writes Chen. “Chinese government bonds offer more attractive yields than their developed-market peers, helped by the prospect of renminbi strengthening, with expected appreciation of 0.8% per year against the USD over the next 10 years.”
The stellar rise in Chinese equities is far from over, says Chen, as the epicentre of the world economy continues to drift towards Asia. As Chinese companies increasingly challenge their developed market peers, Chinese equities could offer superior returns, he adds.
Meanwhile, India’s nominal GDP growth may reach an annual average of 6.5% for the period 2023–2031 compared to last year’s forecast of 6.8%, says Chen.
The slightly dimmer forecast is based on a rising working-age population, the current government’s labour laws, manufacturing sector reforms and pro-growth measures, while also taking into account the challenges in implementing structural economic reforms, says Pictet.
Outside of China and India, Pictet forecasts a 3.2% annual GDP growth for the period 2023-2031 for the rest of Asia, consisting mainly of South Korea, Taiwan and Southeast Asia. “South Korea and Taiwan both face the challenges of a shrinking population that will weigh on public finances and economic growth, as well as the escalating geopolitical risks given the central role both play in global technology supply chains,” writes Chen.
Meanwhile, Southeast Asia will likely benefit from global supply chain migration of labour-intensive sectors out of China, says Chen.
Notably, Pictet has singled out Vietnam to outperform as a major recipient of foreign investment and a growing export-oriented economy in the decade to come, benefitting from its favourable demographic dividend, export-driven and socialist-oriented market economy, as well as heavy investments in infrastructure and education.
Vietnam’s figures back up the claims. Between 2005 and 2019, Vietnam exports grew 717%, or 16.6% annually, from US$32.3 billion to US$263.5 billion, while its average GDP growth of 6.0% places the country with a relatively young population of 96 million only slightly behind China and India.
Climate change and inflation
This edition of Horizon spotlighted the impact of climate change on economic projections and the expected returns of 50 asset classes in the next decade. As governments and central banks steadily integrate climate-change issues into their policymaking, Christophe Donay, head of asset allocation and macro research at Pictet Wealth Management, expects these issues to affect everything from asset-class dynamics to strategic asset allocation and investing styles.
Calling climate change “one of the most important externalities” hanging over economies and markets, Donay foresees higher inflation by a projected 10 bps per year over the next 10 years in major economies.
As climate risks take centre stage in finance, global disparities may widen. Emerging market equities may be hurt more than their developed market counterparts due to higher exposure to climate risks, says Pictet. “Segments of the market that are less carbon-intensive (Nasdaq) or more advanced on transition efforts (Europe) should also benefit on a relative basis. European and Swiss equity indexes are the only ones for which aggregate climate impacts are positive on an absolute basis.”
Developed market equities will bear the cost of the climate transition, as carbon taxes and tariffs pose a drag on returns in the coming decade. According to Chen, global climate change is an externality of the global economy that needs to be internalised gradually. “There are costs imposed on the entire world by carbon emissions that were previously considered free. But increasingly, that cost will be made explicit and will need to be paid by emitters. So, this is going to add to production costs, and that [may lead to] potentially slower GDP growth and higher inflation.”
Horizon’s analysis expects MSCI World index and US equities to report an annual average total return of 5.7% over the next 10 years, and European equities, 5.1%. Nasdaq is projected to deliver an annual average return of 8.5% over the next 10 years, 280 bps above the expectation for US equities at large.
Meanwhile, emerging market equities are expected to deliver high returns in the next 10 years at an annual average of 6.8%, due to strong economic growth and steady dividends. “[Their performance] will depend on the ability of emerging economies to grow sufficiently faster than developed countries to justify the extra risk,” writes Pictet.
60/40 no more
With higher inflation on the cards, Donay is making a case against the classic 60/40 allocation of equities and bonds respectively in a typical portfolio. “From a strategic asset allocation perspective, the expected rise in inflationary pressure, in part because of energy-transition policies over the next 10 years, is a further argument in favour of endowment-style investing.”
Endowment investing, Donay explains, is split into three buckets. “Endowment is something much more granular… One third invested in equities, one third invested in bonds and one third invested in illiquid assets.”
On bonds, Donay points to China, as Pictet expects returns of 5.7% from a Chinese high yield bond, versus just 3.4% from its US counterparts.
On illiquid assets, Donay believes it “makes sense” to diversify into private equity real estate and gold.
Noting the struggle of REITs during the pandemic, Horizon’s analysis shows that private-equity real estate instead delivered a “more or less” flat return last year. The pandemic exacerbated existing trends, with online retail boosting demand for logistical facilities whereas traditional retail outlets suffered, says Pictet.
“Overall, however, real estate can provide a fairly stable cash flow stream and better returns than sovereign bonds inside a globally diversified portfolio. Our analysis shows similar ups and downs in REITs as in private-equity real estate, but REITs perform more like equities during market jitters and in the long run.”
Pictet expects global REITS to deliver an average annual return of 5.8% over the next decade, the same as for private-equity real estate.
Finally, core infrastructure has proven “very resilient” to the disruption brought about by Covid-19, says Pictet, while infrastructure spending as a way of boosting the post-pandemic recovery has moved to the top of the political agenda. “We expect the strong total returns delivered by private core infrastructure since 2007 of 8.0% p.a. on average to continue at a healthy, albeit slower, pace of 5.6% p.a. in the 10 years ahead.”
Infrastructure as a separate asset class is here to stay, as there will be a massive need for investment worldwide in this area in the coming decades, says Pictet. “The public sector will not be able to meet this need fully, thus requiring private players to fill the gap. The tight link between the UN’s Sustainable Development Goals and infrastructure also makes the latter attractive to ESG-conscious investors.”
“Healthy returns, high cash yields and strong diversification are among the many reasons why we expect private infrastructure’s popularity to keep growing among institutional investors over the next 10 years.”