Kevin Gardiner: Looking for long-term growth from investments

11 Jan 2019 Expert insight

Far-sighted trustees shouldn’t give up on growth, says Kevin Gardiner.

Charity trustees have to take a longer-term view than most investors. Some endowed funds have been around for hundreds of years, and aim to be around in perpetuity. Many others have time horizons that stretch well beyond individual or even family lives.

Individual trustees may not see the voyage through, but while they’re on board they are legally charged with the safe stewardship of some venerable – and very visible – philanthropic ventures. They are not usually paid for the worry.

The long-time horizon can amplify the responsibility. Charities whose current expenditures and disbursements are large relative to their donations and assets can feel pressurised by recent market volatility, and are vulnerable to unexpected rainy days and austerity programmes. They need to keep a big portion of their investable funds in liquid and relatively stable assets that can be realised quickly, no matter how far-sighted they try to be.

If budgets permit, however, a long-term view presents opportunity. A lengthy time horizon allows trustees to consider a wider range of investments. Historically, this has allowed many endowments to share in long-term economic growth by devoting more of their portfolios to illiquid and volatile investments such as real estate and equities.

Risky portoflios

Such portfolios are riskier than those which devote more space to (for example) government bonds and cash. And nobody enjoys taking investment risk, no matter how far-sighted they’re being. Investors are not always – or routinely – compensated for holding riskier assets. If they were, it wouldn’t be risk. The neat risk premia that we find in the finance textbooks are useful teaching aids, but do not exist in reality. Riskier assets have performed on a very long-term view, but that is because of their growth – they have performed despite their risk, not because of it. Charities whose funds are large relative to their current commitments do not have a greater appetite for investment risk – but they do have a bigger capacity to bear it.

Such riskier portfolios only offer useful opportunities if such long-term economic growth is still achievable, of course. And in the aftermath of the global financial crisis, which reached its climax more than ten years ago, it has become fashionable to question that assumption.

Economists have identified quite a list of concerns. It is dominated by D-words – debt, demography, deflation, decadence, depletion and danger. In addition, the notion of a savings glut is part of the secular stagnation hypothesis revived by US economist and former treasury secretary Larry Summers in 2013. Most recently, robotics and artificial intelligence have been added to the list.

We think the idea that the world has gone ex-growth is mistaken. There isn’t space to tackle the issues fully here, but we can at least offer a different perspective.

Too much debt?

For individuals, debt can be a life-changing burden. But collectively, we own the banks from whom we’ve borrowed. Nor is it possible, as some suggest, for us to have borrowed from future generations. There is no right level of debt. If a wealthier world has more assets, it will have more liabilities too. The global balance sheet has been growing for decades, and it is not obvious when, or if, it needs to reverse. The debt debate should really focus on the distribution of liabilities, not their gross amount. And there is in fact little sign yet that its unequal distribution is harming economic growth. Financial crises are usually about systemic liquidity, not solvency.

A demographic timebomb?

For at least a quarter of a century, we have been told that our aging populations pose a major economic threat. We have also been told that unemployment is too high. So do we have too few or too many potential workers? In practice, we don’t use all the labour currently at our disposal as efficiently as we might. Moreover, much economic growth comes from productivity, not extra labour input. An older society is not necessarily going to be a poorer one: our collective pensions – and care costs – are likely sustainable.

Looming deflation?

Since the Great Depression, there has not been a sustained, significant fall in consumer prices in a major economy (and if we face another depression, we’ll have enough on our plates without having to worry about consumer prices). There are no recorded cases of hyperdeflation, whereas hyper-inflation has caused untold distress (recently in Zimbabwe, currently in Venezuela).

Nonetheless, economists have been arguing that deflation is a risk, and would make that perceived debt burden even bigger. Some have suggested that central banks should redouble their efforts at creating more inflation, which would be a bit like setting fire to your house to deal with a damp problem.

Decadence, resource depletion, geopolitical danger?

A reduced dependence on manufacturing is not a sign of Western decadence but of prosperity: the West, including even a post-Brexit UK, will likely continue to make many high value-added world-leading manufactured products, but also choose to spend an increasing amount of its income on intangible services.

Economists have said before that we are about to run out of food, or oil, or metal, only for new supplies, improved technology, or substitutes, to be found. The China-driven commodity supercycle of the noughties is just the most recent illustration. The planet’s resources of course need careful stewardship, but may be more plentiful than many fear. As Sheikh Yamani said, the stone age didn’t end for lack of stone…

The current geopolitical backdrop feels fraught, but we can remember far worse even in our post-war lifetimes (the Iran-Iraq war, US-USSR mutual assured destruction). Steven Pinker in 2011’s Better Angels of our Nature collated facts and figures to back up this intuition. This is not the most dangerous epoch in history, but the safest. That could change, of course. But the risks are perhaps more evenly balanced than imagined, as 2018’s unexpected US-North Korea summit illustrated for a while at least.

A savings glut?

This is the core of the secular stagnation hypothesis. The idea is that the global economy somehow is primed to save too much, making aggregate demand chronically weak. Unfortunately, cause and effect can become confused. The big savings surpluses run by Germany and Saudi Arabia, for example, are not the result of their wish to save lots, but the by-products of industrial success and high oil prices respectively. China’s savings surplus has been fading as the economy opens up more (or at least was doing, until Mr Trump came along), and Japan’s may fade too as its economy gradually becomes more capitalist in nature. If there really was a glut of savings, the global economy would not now be almost two-fifths bigger than at its pre-crisis peak.

Robots and AI will take everyone’s jobs

This idea has duped some really smart people, but it is perhaps the flakiest worry on the list – not least because if robots have all the jobs, who will buy the stuff they make? As Henry Ford said: “It’s not a good idea to sack your customers.”

There will be losers from new technology, and a civilized society must find ways of providing safety nets and retraining. More of those losers than in the past will be in white-collar jobs (with some other, non-automatable occupations – plumbing, nursing – perhaps moving up the pecking order for a change). But the new industries that none of us can foresee now (just as in the 1970s we didn’t see mobile communications and digital media coming) may more than compensate, as was the case with the three earlier industrial revolutions.

And whisper it quietly, but intelligence is not the same as data mining and processing speed. If we don’t know how we are programmed, how can we programme a computer to think like us?

Conclusion

In conclusion, we think recent growth worries have been overstated. And at a more parochial level, this applies even to a post-Brexit domestic UK economy. We can’t put a positive economic spin on leaving the EU, but we doubt it will be a complete game changer.

To some extent, the worries were perhaps an understandable response by an embarrassed economics profession to a global financial crisis which it failed to predict – an example of being wise after the event. But in fact, an underlying pessimism about the future is the norm, for reasons that have more to do with psychology than economics.

An honourable exception to this norm was a more independently-minded US professor, the late Julian Simon, who suggested many years before the global financial crisis that “the material conditions of life will continue to get better for most people, in most countries, most of the time, indefinitely… however… many people will continue to think and say that the conditions of life are getting worse.”

You haven’t heard of him because he was quietly right, not loudly wrong. He didn’t blog or tweet. We agree with him, and advise that risk-bearing capacity in long-term charity portfolios should stay allocated to growth-related assets.

Kevin Gardiner is global investment strategist at Rothschild Private Wealth

Charity Finance wishes to thank Rothschild Private Wealth for its support with this article

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