Q4 Outlook On Global Trends

We are likely past the peak in year-on-year GDP growth rates, but growth is likely to stay elevated, thanks to consumer spend- ing, retailer restocking, and monetary and fiscal stimulus mea- sures. This should drive ongoing robust earnings growth: we are looking for 42% growth in global corporate earnings this year and 9% in 2022. We think this is a good environment for equities overall, and in particular for the energy and financials sectors, US mid-caps, and companies exposed to economic reopening. In contrast, we see limited upside for sectors like industrials, real estate, and consumer staples.

Energy, financials, US mid-caps, reopening winners

The energy sector has been under pressure in recent months as concerns about economic restrictions in China have weighed on oil prices. But oil prices have since rebounded and we expect them to stay elevated for the rest of the year, as demand continues to grow while OPEC+ remains cautious about increasing supply. As a result, global oil inventories should decline by around 140mn barrels in 4Q21, in our view, keeping the market in deficit by 1.5mbpd. Energy stocks are still only pricing in a Brent crude price of USD 55–60/bbl, ver- sus our year-end forecast of USD 75/bbl.

We think financials are well positioned for the months ahead. Strong corporate profitability should mean reduced loan-loss provisions, and loose financial conditions should support credit growth. Meanwhile, the Fed’s moves toward tapering quanti- tative easing should drive higher longer-term yields (we fore- cast US 10-year yields at 1.8% by year-end), boosting net interest margins.

US mid-caps offer a balance between cyclical and quality expo- sure, which we think is attractive at this point in the recovery. Earnings growth is outpacing large-caps—by 2022 mid-cap earnings are likely to be 54% above 2019 levels, versus large- caps at 34%, in our view—and mid-caps are trading at the largest discount to large-caps in 15 years at around 20%.

Recently, the relative performance of mid-caps has shown cor- relation with bond yields. If bond yields are rising (as we expect) on prospects for stronger economic growth, this should also support mid-caps versus large-caps due to the for- mer’s more cyclical nature.

We also see potential for recovery in select stocks exposed to economic reopening across the US, and for investors outside of the US we have also identified opportunities in Asia and Europe. The reopening trade has been hurt in recent months by concerns about the delta variant, but we expect a catch-up in the months ahead, as vaccination rates pick up, booster shots are rolled out, and mobility restrictions are removed more permanently. In the US, our list focuses on companies that should benefit from pent-up demand across leisure, energy, and financials. In Asia, we identify stocks from six industries hit hardest by the pandemic, including capital goods, consumer services, and transportation, and which have high earnings potential as parts of the region reopen. In Europe, we focus on cyclical stocks with relatively solid finances across industrials, and consumer discretionary and staples.


Japan is our most preferred region for the final quarter of the year. Emergency COVID-19 restrictions have weighed on the country’s equity market performance in recent months. That said, we think now is the time to invest in Japan for three main reasons. First, the recently announced departure of Japan’s Prime Minister Yoshihide Suga could mean further fiscal stimulus following a shift in leadership, with both frontrunners pushing for it. This, combined with a broader vaccination program, should facilitate stronger domestic growth and boost investor sentiment. Second, Japan’s earnings strength hasn’t been priced in. We forecast corporate earnings growth of 42% for the fiscal year ending March 2022, which is in line with our global fore- cast; with the Japanese market (MSCI Japan) trading at a 14% discount versus the global index (MSCI ACWI) on a 12-month forward PE basis. Third, the index is extremely cyclical—over 40% of MSCI Japan’s revenues come from abroad, and we expect global real GDP to grow 6.2% this year, followed by 5.1% next year.


The current economic environment is conducive for higher commodity prices, in our view, and we expect broadly diversified commodity indexes to deliver mid- to high-single- digit total returns over the next three to six months. We think the Brent crude price should stay elevated at USD 75/bbl into year-end as the trend toward economic reopening supports a recovery in oil demand and a decline in inventories. Elsewhere, with the copper market still in deficit, we forecast prices will rise to USD 10,000/mt by year-end (from USD 9,560/mt at the time of writing).

Limited upside in some sectors

To invest in the opportunities outlined above, we recommend that investors reconsider their exposure to global sectors like industrials, real estate, and consumer staples—especially in stocks that have recently outperformed but which we think have limited upside ahead. After an impressive performance in the past year for global industrials (up over 30%), valuations are now relatively expensive, China’s GDP growth has started to slow, global leading economic indicators are rolling off their highs, and rising input prices may lead to some cost pressures for small- and mid-cap manufacturers, which will likely weigh on performance.

Consumer staples and real estate also remain least preferred. The consumer staples sector (MSCI ACWI Consumer Staples) is relatively expensive at over 20x forward P/E relative to its own history; also, it is facing rising input costs, and is negatively correlated to higher bond yields. Meanwhile, we believe it is too early to position in a late-cycle industry such as real estate, and the sector is facing structural headwinds in the office and retail segments as a result of the pandemic, although rental income remains stable.

Why should stocks move higher from here?

Many global stock indices stand at, or near, record highs, which can make it difficult for investors to see further upside poten- tial. But we continue to believe global equities can rise further.

First, although many stock markets have performed strongly year-to-date (the S&P 500 is up 22%, Euro Stoxx 20%, SMI 16%), this is almost entirely explained by earnings upgrades. And that strong earnings growth is set to continue. We expect S&P 500 EPS of USD 207 in 2021 (45% y/y growth) and USD 227 in 2022 (10% growth).

Second, valuations are not stretched if we consider the current level of bond yields, and even if bond yields rise in line with our expectations, valuations still look alright. In absolute terms, our price target for the S&P 500 at 5,000 at the end of 2022 assumes a forward P/E of around 20x, which is above the historical average of 15.3x. But given the very low interest rate environment, the equity risk premium (S&P 500 forward earnings yield minus the US 10-year Treasury yield) remains at 3.1% versus a historical average since 1960 of 0.8%. And even if the US 10-year Treasury yield rises to 1.8% by year-end, as we forecast, the equity risk premium should stay above long-term averages.

Third, our view for the likely path of the business cycle also supports our expectations for continued gains. Business inven- tories in the US look very low. We can quantify this by looking at the customer inventory component of the ISM manufacturing index. Right now, it is near a record low at 30.2. When this metric is below 40, the headline ISM index tended to remain healthy for at least the next year. This is important because there is a strong correlation between the headline ISM reading and equity market performance—when the headline ISM is decelerating but remains near healthy levels, subsequent 12-month S&P 500 gains are typically strong.

More generally, although record highs can be unnerving, in the past all-time highs have not been indicative of weak future performance. One-year S&P 500 returns after a record high since 1960 on average have been 11.9%, versus 11.7% when the index was below a record and historically, the probability of a subsequent 10% drawdown after an all-time high was just 30%, versus 36% at any time.

Investors who are nonetheless still cautious about committing capital have several options. First, they can mitigate market timing risks by setting a schedule for phasing into the market, e.g., over a 12-month period. Second, they can employ put- writing strategies that allow them to earn a yield and poten- tially enter markets at a lower level if markets fall. And third, they can also use structured investments with asymmetric pay- off profiles as an alternative to having direct exposure to a security—for example structures which offer a degree of capi- tal protection or have a fixed coupon payment until maturity based on movements in underlying markets.

02 Seek “unconventional” yield

The substantial fall in bond yields and the compression in credit spreads in 2021 mean that the opportunity set in public bond markets is now limited, and even “high yield” credit has only limited return potential in the US and Europe—although the outlook for Asia is still positive, in our view. Investors hold- ing cash or traditional bonds but looking for additional income now should consider alternative means of yield generation, across private credit, senior loans, active fixed income, direct real estate, and FX, or by employing leverage or volatility- linked strategies.

Alternative fixed income

With yield opportunities in traditional fixed income markets limited, we think now is a good time for investors to review opportunities to generate fixed income returns in alternative fixed income strategies:

Private credit—As an alternative to listed credit, private credit allows investors to harvest an illiquidity premium and to generate a higher yield for those who can accept the addi- tional risk and longer investment time horizon of the asset class. Year-to-end-June, the Cliffwater Direct Lending Index generated 7.3%. Falling middle market default rates and ele- vated leveraged buyout deal flow indicate healthy market conditions and plentiful opportunities for capital deployment. High levels of competition, however, are driving more aggres- sive loan pricing, and selectivity is warranted.

US senior loans—While we no longer view US high yield credit spreads as appealing relative to the risk, we still think US senior loans offer an attractive yield at 4.4% (based on the S&P/ LSTA Leveraged Loan Total Return Index), and the asset class

should benefit from healthy corporate earnings, with default rates below their long-term average. Returns have lagged US high yield by 2ppts year-to-date, but we still see room for mod- est spread compression and maintain our preference for senior loans. In addition, as fears over potentially higher interest rates mount amid Fed commentary about tapering, the floating rate structure is another reason why investors should consider senior loans now—the asset class has also experienced positive net inflows year-to-date, whereas US high yield has seen outflows.

Asia HY—While the strategy may not be available in all regions, one pocket of public bond markets where we do see value is in Asia high yield, though many global investors lack exposure.

Tighter policies in China’s property sector, ongoing negative headlines around a leveraged property developer, and uncer- tainty about China’s regulatory direction have weighed on Asian HY bonds in recent months. But we think the risk-reward out- look for the next six months is constructive, and current valua- tions should provide a buffer against further drawdowns. We prefer BB rated bonds, shorter-dated quality Chinese property issuers, and bonds in the commodity and industrial sectors.

Active approaches—Fixed income investors can also enhance returns by employing more active approaches in the asset class. For example, if rating agency moves are anticipated correctly, investors can generate alpha, provided they are able and willing to tolerate the volatility in these “rising stars” and “fallen angels.” While rating agencies have lagged so far this year with their ratings upgrades after an avalanche of downgrades in 2020, upgrades are now coming through, and rising stars’ bond volumes are exceeding fallen-angel bond volumes this year.

With credit quality set to improve further, we anticipate a grow- ing number of issuers migrating from the high yield to the investment grade category over the coming quarters.

Direct real estate

The pandemic has driven significant change in the real estate market, with hotels and retail real estate particularly suffering from mobility restrictions. In addition, people are starting to consider the opportunities offered by remote working possibilities, with traditional business centers like Manhattan, San Francisco, and London suffering from lower demand. But while as a whole, total returns for residential and office properties declined in 2020, there was still stable rental income. We think rental income will remain stable at around 4% across offices (as demand recovers), residential properties, and logis- tics as the economic recovery broadens and shifts away from government support schemes, and that global direct real estate across all property types offers an attractive opportunity for investors seeking income.

We think the asset class (based on the MSCI IPD Direct Real Estate Index) will generate almost 5% in returns in 2022, led by industrial and logistics properties (up >10%), followed by residential (up >8%), and office properties (up 5%), supported by solid global transactional liquidity and favorable financing conditions. As direct real estate’s total return is not closely cor- related with other asset classes (e.g., equities, bonds, com- modities), it can offer diversification benefits in a risk-adjusted portfolio context. We focus on global direct real estate funds that seek to create value through active management, sub-sec- tor asset selection, and broad geographical diversification in core and core-plus properties.

FX: Hawks vs. doves

After close to two years of broadly homogenous emergency central bank policies around the world, monetary policy is now at an inflection point. Of course by historical standards, central banks globally are still extremely accommodative, yet even in this environment we do see relative “hawks” (who are more likely to tighten policy) and relative “doves” (who are more likely to retain part of their current loose settings). We think this is likely to drive an increase in currency dispersion.

The relative “hawks” include the Norges Bank, the Bank of England (BoE), and the Federal Reserve, while the “doves”— the European Central Bank (ECB), the Swiss National Bank (SNB), and the Bank of Japan (BoJ)—favor accommodative pol- icy and negative rates for longer, due to still-low core inflation.

Assuming the recent uncertainty caused by the delta variant is transitory, policy divergences between the ECB and the SNB versus Norges Bank and the BoE should lead to a widening in yields in favor of the NOK and the GBP. In our view, going long GBP and NOK and short EUR and CHF should provide a mid- single digit percentage upside on a total return basis over the next six to 12 months. This view is reflected in our forecast that EURNOK will decline to 9.70 (vs. near 10.20 now) and GBPCHF will rise to 1.33 (vs. near 1.28 now) by March 2022.

Outside of Europe, we expect the US dollar to appreciate rela- tive to the Japanese yen, as the “hawks vs. doves” narrative plays out. We expect USDJPY to reach 114 by March 2022, from 109 currently.

Options and structured investments

For investors who can trade options, current equity market conditions offer opportunities to benefit from elevated volatil- ity risk premiums, in our view.

According to our volatility regime indicator, in March 2021 the VIX index moved from a high state of volatility that started with the pandemic to a medium state. While the price of options has fallen over the course of the crisis, they are still not cheap by historical standards. Therefore, investors looking for alternative solutions to generate income can use this elevated volatility premium to sell options and generate yield.

With equity markets trading near all-time highs, investors can also consider reverse convertibles as an alternative yield solu- tion while waiting for better entry points, both on an index level and on thematic single stocks.

03 Diversify with alternatives

With bond yields at low levels, portfolio diversification is increasingly challenging for investors, particularly against a backdrop of global equity markets at all-time highs, and emer- gent risks including the delta variant, China regulations, and geopolitics. Investors looking to diversify sources of risk and return should consider both hedge funds and private markets, as well as structures that can deliver alternative payoff profiles

Hedge funds

The hedge fund industry continues to enjoy a period of deglobalization, as well as economies normalizing at varying speeds are all opportunities for managers to take advantage of. We think hedge funds offer an appealing combination of potential for attractive risk-adjusted returns, less downside sensitivity than equities, and diversification.

CIO Capital Market Assumptions 2021 – 15-year expected returns and volatility strength. After delivering double-digit returns in 2020, the average hedge fund is up between 5% and 10% year-to-date, according to HFR indexes. The asset class registered over USD 18bn of net inflows this year, with survey data indicating inves- tors plan to allocate more in the coming months.

Hedge funds can be a particularly effective tool to increase portfolio diversification. Although hedge funds have only out- performed a rising equity market three times in the past two decades, in almost every year that equities have fallen, hedge funds have outperformed stocks. Historically, hedge funds have both suffered smaller drawdowns and recovered faster than equities during crises, and data since 1990 suggests add- ing hedge fund exposure has improved the risk-return profile of a multi-asset portfolio.

Importantly, market technicals such as dispersion and correla- tions remain conducive for returns. The transition to a refla- tionary environment with fundamentals taking the forefront, structural themes such as sustainability, digitalization, and deglobalization, as well as economies normalizing at varying speeds are all opportunities for managers to take advantage of. We think hedge funds offer an appealing combination of potential for attractive risk-adjusted returns, less downside sensitivity than equities, and diversification.

Private markets

In 1Q21, the latest data available, the Global Cambridge Asso- ciates Private Equity index, which tracks more than 2,000 funds, rose 7.73% versus 5% for the MSCI World. Also, buy- out strategies delivered 7.32% in 1Q21 compared to 8.81% for growth equity strategies. Yet overall, we continue to see private markets as attractive, offering an alternative source of growth, income, and alpha potential:

Growth—Private equity affords exposure to earlier-stage growth companies than generally available in public markets. For example, 497,000 tech companies globally are privately held, compared with just 8,100 that are listed on public exchanges. Currently, private equity investors are particularly active in fintech, digital subscriptions, healthcare, and in sec- tors benefitting from the shift to more sustainable economies.

Income—In exchange for less liquidity, direct lending and core real asset strategies can provide enhanced income opportuni- ties in excess of public market returns, with a typical yield of 400–600bps above LIBOR for first lien loans to middle market companies. We also view real asset strategies such as core real estate or infrastructure as an attractive way to improve diversi- fication and hedge against longer-term inflation.

Alpha—Many companies borrowed from private lenders and on capital markets at the height of the pandemic to address acute liquidity and financial stress. As the recovery takes hold, these companies are reassessing core operations and compe- tencies, and potentially selling underperforming or non-strate- gic businesses to reduce debt and/or improve operational effi- ciencies. Private equity investors can acquire these businesses at potentially lower valuations, leverage their expertise to cre- ate value and generate returns.

Overall, private markets can offer a potential way of enhanc- ing portfolio returns, and increasing diversification. While requiring commitments over a longer time-frame, private mar- kets have historically generated higher returns than listed mar- kets—between 2001 and 2020, such strategies outperformed their public counterparts by just over 3ppts per annum*. This can partly be attributed to an illiquidity premium, which is esti- mated to have been 1–3 percentage points per year.

Options and structured investments

Current options market conditions, in our view, offer opportu- nities to benefit from attractive payoff profiles available through structured investments and option strategies.

The rapid decline in interest rates following the pandemic has led many investors to seek alternatives to bonds to protect their portfolios against a fall in stock markets. As a conse- quence, the demand for put options, which help protect against equity market declines, has increased. With increased demand, the relative price of downside protection has risen: downside skew, which measures the difference between the implied volatility of 10% out-of-the-money and at-the-money put options, is currently above the 95th percentile for the past five and 10 years for major US and European equity indexes.

This means that investors looking to hedge equity exposure should consider put spreads, or similar structures, that com- bine both long and short positions to cheapen protection. Alternatively, investors who would like to participate in further upside but fear short-term pullbacks, could consider using risk reversals, as the elevated skew enables them to benefit from payoff asymmetry in these structures.

For investors unable to invest in options directly, similar payoff structures may be available using structured investments such as bonus certificates or airbag structures.

04 Seek opportunities in healthcare

We think the global healthcare sector offers an appealing combination of defensive and long-term growth features, combining relatively inelastic demand and attractive long-term structural drivers. The sector tends to outperform after eco- nomic indicators peak. Pharmaceuticals are the most defensive industry within the sector, while medtech stocks are more geared to the post-COVID-19 recovery. Transformational themes such as healthtech and genetic therapies provide expo- sure to longer-term structural growth. We think investors should include all of them in their portfolios.

Defensive subsectors

Pharma stocks constitute around half of the sector’s capitaliza- tion and are the most defensive subsector, with revenue and earnings not being driven by the economic cycle. Healthcare utilization is recovering from the pandemic, meaning drug pre- scription volumes are increasing, and the sector’s recent improvement in earnings momentum looks set to continue. As of early September, global pharma stocks were trading at a roughly 15% discount to the broader equity market on a for- ward 12-month basis, which is near a 20-year low. We expect this discount to narrow, especially if US drug pricing legislative and regulatory risk is resolved by year-end.

Medical devices. Medtech stocks, which account for around a third of healthcare capitalization, offer near-term defensive characteristics along with structural growth. Medtech benefits from consistently growing end-markets, new product introduc- tions, and a lower penetration in emerging markets, offering scope for a catch-up. In the US, the industry also faces less political pressure on pricing compared to pharmaceutical com- panies. Medtech companies should benefit in the near term too as the pandemic subsides, and patients undergo medical procedures that had been deferred. We see the potential for a significant catch-up in procedure volumes that will support accelerating growth in the fourth quarter.

Structural growth opportunities

Healthtech aims to make healthcare more efficient by improv- ing outcomes while saving costs. The pandemic has acceler- ated change in the healthcare system, exemplified by the tele- medicine boom, and there are growing signs that stakeholders now recognize the potential for digital technology to help check the relentless growth of healthcare spending around the world. Even though performance has lagged slightly this year, following a strong outperformance versus global equities last year, momentum picked up again over the last three months, and structural changes to our healthcare system are here to stay, in our view. We recommend a diversified portfolio approach to investing in healthtech. Long-term investors could consider direct investments through private equity to capture an illiquidity premium.

Genetic therapies modify genetic information, with the intent of curing disease. Unlike traditional drugs, which usually just slow disease progression or relieve symptoms, genetic therapies aim to cure diseases by modifying or removing faulty human genetic information. This represents a paradigm shift in medical care today. So far, seven of these treatments have been approved in the US, and the FDA has indicated it expects to approve 10–20 new cell and gene therapies every year by 2025. We estimate the first treatments to reach the market could achieve combined sales exceeding USD 20bn. The lon- ger-term potential is large but difficult to quantify currently, and performance has been relatively volatile after substantial outperformance last year. We recommend a diversified portfo- lio of companies exposed to the theme given the idiosyncratic risks of drug development.

05 Position for net-zero carbon transition

The transition to net-zero carbon is underway. This should continue to benefit companies developing greentech and clean air solutions, as well as creating new opportunities in carbon markets. These strategies are all part of a broader shift toward sustainable investing—our preferred approach for investing globally.


Our “greentech goes global” theme highlights companies that will play a key role in the global energy transition. While car- bon neutrality goals are long term, we see attractive invest- ment opportunities emerging in the short to medium term:

The EU has recently launched “Fit for 55,” an ambitious policy action plan to reach Europe’s climate targets, while carbon credit prices in the EU have tripled since November. This fol- lows major economies including the EU, China, and the US issuing net-zero carbon pledges in the last 12 months, prompt- ing plans to spend trillions of dollars to deliver a “greener” recovery with a cut in carbon emissions. By 2050, the Interna- tional Renewable Energy Agency (IRENA) expects USD 131tr of investments prioritizing technologies that are consistent with a pathway to limit the global temperature rise to 1.5°C by 2050 (as agreed in the Paris Agreement)—more than 80% of that needs to be invested in energy transition technologies such as renewables, energy efficiency, and power grids. These strong secular drivers, combined with a renewed focus on the green- tech story at the COP26 conference in November, should help drive the performance of our theme, which has outperformed global equities markedly since May.

Our investment theme focuses on leading companies active in renewable energy, transport, batteries, hydrogen, digitaliza- tion, and energy efficiency. More broadly, investors can also gain exposure to global greentech through investing in stocks linked to the future of Earth, i.e., those companies that are working toward health, community planning, energy transi- tion, sustainable agriculture, and water scarcity solutions, or by investing sustainably through sustainable asset allocations— our preferred approach for clients looking to invest globally.

Clean air

As the world shifts toward net-zero carbon, we see four focus areas to reduce CO2 emissions: renewables (in power genera- tion), electric vehicles (in transportation), energy efficiency (in buildings), and hydrogen (in industry, transportation and build- ings). In some countries, carbon capture and storage will also be an important technology to achieve decarbonization targets.

Given carbon neutral pledges by a number of large countries to reduce emissions, the use of clean-air technologies should accel- erate, and investment should increase rapidly. Mentions of envi- ronmental, social, and governance (ESG) issues in corporate documents, particularly climate change, have grown by over 25% year-on-year in the US and over 50% in Europe, according to AlphaSense and Deutsche Bank.

Our clean air and carbon reduction theme has performed roughly in line with global equities this year. But momentum should increase, with a renewed focus on climate change at COP26. Looking ahead, we think our theme will generate 5–10% annual earnings growth over the long term and require investment of around USD 60tr by 2040. Providers of solutions to reduce emissions should benefit the most.

Carbon trading

The ability to put a price on carbon is one key mechanism in some government strategies to hit net-zero targets and encourage sufficient investment in low-emission business models. The European Union’s Emissions Trading System (ETS) was the first cap-and-trade system and is the most liquid.

Prices on European carbon recently hit a record high, having rallied almost 85% year-to-date, due to higher energy demand, and anticipation of tighter environmental regulations in the future.

We think that continually lower availability of emission allow- ances, and an increase in scope of the current system to more sectors should support carbon prices over the medium to long term. Investors, however, should be aware of the potential for short-term price setbacks and the elevated volatility of the European carbon price.

More generally, the implementation of cap-and-trade systems should benefit industries that are more efficient at managing their carbon emissions. Outside of the most emission-intensive industries like the power sector or transportation, companies that are ESG leaders in managing their carbon footprint and climate-related risks and opportunities should benefit from the long-term net-zero carbon transition.

Sustainable bonds

Sustainable bonds comprise of green, social, sustainability and sustainability-linked bonds, making up an investment uni- verse of around USD 1.8tr and growing rapidly. Green bonds make up the largest part of this universe (with over USD 1tr in bonds issued), with the proceeds used to finance projects that provide clear environmental benefits, such as renewable energy, energy efficiency, and sustainable agriculture. For example, the green bonds assessed by Moody’s should save around USD 2.6mn metric tons of annual carbon emissions— the equivalent of the annual electricity use of just over 470,000 homes, or the charging of 316bn smartphones, or the amount of carbon emissions saved by switching 98.5mn incandescent lamps to LEDs, according to Environmental Pro-

tection Agency data. Just as green bonds aim to target envi- ronmental issues, social bonds aim to address social chal- lenges. Sustainability bonds combine to address both environmental and social challenges, while sustainability-linked bonds are linked to the issuer achieving ESG targets. For exam- ple, if the issuer fails to meet a goal on reducing carbon emis- sions, it could end up paying a higher coupon to bondholders. Overall, we think the sustainable bond market is able to deliver returns comparable to traditional bonds, but as with tradi- tional credit investing, picking the right names—across devel- oped and emerging markets, and from investment grade to high yield—can also deliver outperformance and provide opportunities to seek “unconventional” yield sources.

06 Invest in long-term themes

Beyond healthcare and sustainability, the digital transformation of sectors ranging from transport to manufacturing and finan- cial services continues. We see particular opportunity in smart mobility and automation, in those companies benefitting from the growth in the digital asset universe, and in cybersecurity, a key enabler of automation and digitalization.

Smart mobility

By 2025, we believe the annual addressable market for smart powertrains (electrification), smart technology (autonomous driving) and smart car use (car-sharing/car-hailing) will be about USD 450bn, or 3–4 times today’s size. By 2030, this could rise to about USD 2tr, driven in particular by how smart mobility addresses climate change and other gas emissions, the regulatory environment, as well as based on technological and cost advances.

We see opportunities across the whole value chain—in makers of automobiles, auto parts, batteries, along with electronic and electric components related to electrification and autono- mous driving, as well as in carsharing concepts. We think Asia in particular will perform a key role in shaping the mobility transition—from determining mainstream designs, features, and price points of electric vehicles (EV) globally—to poten- tially creating brands that win market share. Led by China, we expect EV sales in the region to grow by a 36% CAGR between 2020 and 2030 due to a combination of a vibrant supply backdrop, substantial vehicle demand, and a race to reduce emissions among governments.

Smart mobility stocks in our theme have performed in line with global equities year-to-date, with momentum in recent months driven by a combination of government policy initiatives, corporate investment plans, and shifting consumer pref- erences—all of which we expect to continue. US President Joe Biden in August set the target for 50% of new US vehicles to be electric by 2030. European and US automakers continue to enhance their electrification strategies, with several announc- ing plans to shift away from combustion engines. Meanwhile, as China moves toward phasing out EV subsidies, sales remain robust, with pure-play EV makers reporting 2–3x year-on-year sales increases year-to-date.

Automation and robotics

We believe automation companies will be among the long- term winners in the aftermath of the pandemic as demo- graphic changes, rising labor costs, the drive for productivity gains, and rising digitalization will support this theme.

The economic crisis in 2020 saw lower investment in the space: our estimate, combining company data and industry estimates, for the size of the market in 2020, at USD 183bn, is lower than for 2019. But we expect a recovery in 2021–22 as companies’ capex rebounds, and mid- to high single-digit growth rates on average in the longer term. Increased trade concerns and supply chain issues highlighted by the pandemic should continue to strengthen manufacturing companies’ reshoring efforts, resulting in more automation equipment investments. For example, around USD 50bn in new US semi- conductor plant investments have been announced over the past year. China is also upgrading its manufacturing sector, with a focus on smart automation. With robot density in China’s manufacturing industry at 187 per 10,000 employees in 2019, compared with 346 in Germany and 364 in Japan, based on International Federation of Robotics data, the struc- tural growth potential is significant. Globally, the Industrial Internet of Things (IIoT), 5G, and industrial software are all key enablers of the transformation to smart manufacturing.

Companies captured by our automation and robotics theme have demonstrated strong momentum in recent months, as well as sound profitability and financial health—overall slightly outperforming global equities year-to-date. Given the cyclical nature of the theme, we expect it to offer opportunities for investors with shorter, more tactical horizons over the coming year as these firms stand to benefit from the global recovery in industrial production.

Digital assets

Digital assets have garnered significant media attention in recent years as Bitcoin, and then NFTs (non-fungible tokens) have broken new price records.

But if we think of the nascent distributed ledger technology (DLT) as an iceberg, the likes of Bitcoin and NFTs only represent the visible top; we think many of the most interesting aspects lie under the surface. DLT has grown rapidly to encompass sev- eral applications, some of which could contribute to efficiency, transparency, and security gains in many areas. The technology may at some point disrupt various industries, including finan- cial service providers, the healthcare sector, public services, manufacturing, and parts of the IT value chain.

From an investment perspective, we recommend investors focus on companies exposed to the underlying technology theme around the evolution of DLTs, rather than engaging directly in cryptos. Although this approach is admittedly much less suitable for speculative gains, we believe its longer-term, risk-adjusted returns look more promising given the uncertain price outlook of coins and tokens.

Fintech companies are one way to build exposure to the techno- logical opportunity, given their first-mover advantage with DLTs and their ability to integrate them in many of their key offerings: we see opportunities in leading payment players, platform com- panies, and disruptors in emerging technologies. But beyond fintech, exposure can also be approached through two broad segments including enablers (such as semiconductors and soft- ware) and platform companies in multiple industries like retail and internet (as well as fintech). Read more in our Long Term Investments reports on Fintech and Enabling technologies.

Private equity can also be an effective way of gaining direct exposure to disruptive, fast-growing, innovative companies, and deal activity linked to DLT has increased significantly over the past year. The first quarter of 2021 saw 239 deals with a combined value of USD 3bn, compared with 174 deals total- ing USD 1bn in the first quarter of 2020, according to Pitch- Book data.

Security and safety including cybersecurity

As the systemic importance of digital systems increases, while the threat of attacks grows, governments and companies are spending more on cybersecurity. The US government, in dis- cussions with both corporations and other governments, in May 2021 issued an executive order on cybersecurity to help identify, deter, protect against, detect, and respond to persis- tent and increasingly sophisticated cyberattacks. China has also announced new rules on IT infrastructure oversight.

The size of the global cybersecurity market was close to USD 145bn last year and has been growing by 8% annually in recent years. We expect that rate of growth to accelerate to close to 10% this year. In the technology sector, cybersecurity is one of several segments that align with our bottom-up pref- erence within tech for small- and mid-cap names, as most cybersecurity leaders are still in the mid-cap space. It is also one of the most defensive segments, and is a key enabler of structural growth themes including 5G devices, fintech, green- tech, healthtech, and automated driving systems.