'Supertanker' trends Climate change and artificial intelligence (AI) are reshaping the future of investing, according to a new research study launched by BNY Mellon Investment Management and CREATE-Research.
89% of the institutional investors, with combined assets under management of approximately $12.75trn, that took part in extensive and structured interviews regard the two supertanker trends as investment risks.
Almost all (93%) view climate change as an investment risk that has yet to be priced in by all the key financial markets globally, while over 85% view AI as an investment risk that could potentially provoke societal backlash as well as geopolitical tension.
The report, Future 2024: Future proofing your asset allocation in the age of mega trends, analyses how climate change and AI are perceived by investors globally, the investment issues and solutions they are giving rise to and the impact of these supertanker trends on asset allocation approaches and the asset management industry.
AI and climate change: risk or opportunity?
Both AI and the climate change are viewed as materially important factors by investors.
Over half (57%) of the respondents view climate change as a risk and an opportunity; 36% view it as a risk only and 7% view climate change as an opportunity only. Investment specific challenges related to climate change centre on areas that are unknowable, requiring judgemental calls about the future. Challenges like slow progress on carbon pricing - envisaged under the Paris Agreement - is leaving investors guessing at what point draconian governmental action will become inevitable; dilemma on the future of stranded assets, with investors weighing up whether to mitigate investment risks now or later at potentially higher costs; engagement with carbon emitters is more difficult for investors in fixed income than equities, with fewer opportunities to engage with companies via voting rights or AGM attendance; and question marks on whether ESG is a risk factor now or will be in the future, as benefits are already captured with other factors such as quality and low variance.
In response to the challenges arising from climate change, investors are factoring in the potential for draconian measures, ensuring they have intensive engagement with companies, increasing investment in green bonds and accepting ESG as a risk minimising tool.
Half (52%) of the investors surveyed, who stated AI was a risk, also regarded it an opportunity, whereas 33% saw it as only a risk and 7% regard it as an opportunity only. The rise of AI is seen to create four investment specific challenges - corporate lifecycles will get shorter as AI creates winners and losers, as shown by the impact of the earliest versions of the iPhone on Nokia in 2007; sectoral boundaries will blur, as AI reconfigures entire products, as seen with Tesla, which straddles multiple sectors, causing valuation issues; onshoring of manufacturing activities will diminish the prospects of emerging economies, with 3D printing shifting the geographical centres in global supply chains; and intangible values of companies will be enhanced in ways that are hard to measure for asset valuation purposes.
In response to these challenges, investors are increasingly mixing active and passive investment strategies, focusing on idiosyncratic risk in portfolios, targeting emerging innovation leaders and blending hard and soft metrics in their analysis.
Changes afoot for asset allocations and the investment industry
Secular themes such as AI and climate change are also key factors driving changes in asset allocation. Overall, new future allocations will favour private markets more than public ones, as the search for uncorrelated absolute returns intensifies. Private debt will be used to support young start-ups, while private equity will be relied upon to capitalise on corporate restructuring driven by AI. The report found that investor allocations to private markets are currently between 19 - 31% but are expected to rise.
Headlong growth in passive funds has been observed in the past decade, with ETFs and smart beta accounting for 20 - 40% of investors' portfolios and is also an area expected to rise in the next decade.