Debt levels point to below average growth in coming years
Unprecedented level of public debt indicates below-normal economic growth ahead, warned Farouki Majeed, chief investment officer, Ohio School Employees Retirement System, speaking to FIS Digital alongside Debt Officer Rich Randall. worldwide at IFM Investors.
Debt beyond a certain point becomes a risk according to Farouki Majeed, who applies this same value judgment to assess any asset at the current level of sovereign debt.
In a panel discussion focused on the dangers inherent in historically high levels of sovereign debt to GDP, he told delegates that debt involves borrowing in the future and that all studies show that countries who have high debt levels have lower GDP rates. growth.
Reflecting on the best allocations in the current environment, Majeed noted that government bonds are no longer a defensive asset: the downside risk of holding government bonds has increased and the negative correlation with equities has increased. ‘is reversed.
“We don’t expect government bonds to play the favorable diversification role that we would normally expect,” he said. The pension fund is currently underweight US government bonds relative to its broad benchmark and overweight investment grade fixed income.
One area that investors can find in COVID is private debt. Allocations to this asset class provide highly secure assets such as infrastructure or transport assets with predictable cash flow, said Rich Randall, global debt manager at IFM Investors.
IFM, which only invests in corporate debt, has found valuable choices in the sector as a result of bank disintermediation from GFC. Banks have ceded much of their loans in developed markets to capital markets, he said, estimating that around $ 3 trillion in private debt is now in the hands of financial markets rather than banks.
In addition, capital markets are a more efficient provider of this debt, lending to sectors that banks don’t like SMEs. Institutional investors are finding returns while companies are able to tap sources of capital, he said. IFM, a large investor in the US energy space, sees opportunities ahead in the development of brownfields and renewable energies.
While Majeed noted the benefits of private debt, he also noted the challenges. Of course, infrastructure debt is a defensive asset, but private assets pose a liquidity risk compared to marketable government bonds.
“You cannot allocate a whole share of the portfolio to infrastructure debt,” he said. Despite this, over the past few years, Majeed has increased the allocation to real assets, including infrastructure equity and debt, the portfolio is also overweighted in cash and it has increased the allocation to stressed credit and debt. difficulty in exiting the pandemic. The private credit portfolio has a higher distributed return than infrastructure and fixed income securities, reflecting a broader strategy to increase the income component of the total return component of the fund, he said.
Randall expects more (business) collapses to occur as economies recover from COVID. Companies that hung on before the pandemic and have been rescued will now face a toll. He also stressed the importance of a close eye on corporate debt levels, especially in certain sectors. For example, service-type businesses are over-indebted and airlines are also heavily indebted. Here, he noted the opportunities of failed angel investors as the top-quality companies fall into the low-grade market.
He also expects opportunities to arise in markets like Australia and Asia, where bank disintermediation is less developed. Debt capital provided by non-banks in the United States and Europe is strong, but in Asia only about 10 percent of debt capital is provided by non-bank institutions. He also warned investors to beware of exaggeration and the profile of managers – returns similar to equities in the private debt arena are unlikely.
“Debt is debt… and if managers demand such high returns, a lot will be taken advantage of at the asset or portfolio level,” he said.
Randall said the private debt market also offers some hedge against inflation since the majority of infrastructure loans are floating rate. He also expressed his concerns about changes in political leadership that swing the pendulum between disparate ideologies. The power transition can have a dramatic effect on how we view infrastructure, he said, citing the current unknowns in the political debate in the United States over funding for social infrastructure.
IFM’s investments are mostly concentrated in OECD countries, Randall said. Although the firm has made a few deals in Latin America, the accompanying volatility has not earned the risk premium. He also noted an imbalance between supply and demand given the role of regional banks in providing capital.
Tackling the mountain of sovereign debt will require either selling assets or raising taxes, but panelists concluded that political leaders were reluctant to do either.
Economic growth, the most desired solution, is unlikely. It is difficult to achieve sustained growth rates, Randall said, adding that 5% growth on a sustainable basis will not happen.