Richard Sarsfield, head of insurance solutions at Morgan Stanley Investment Management (MSIM), discusses the attractions of emerging markets and his outlook for the multi-asset investment space in 2023
What factors have driven MSIM's strong performance in emerging markets?
MSIM's emerging markets debt team owes its consistent, historical outperformance to three distinct advantages honed over the last three decades. First, the largest investment universe possible presents an opportunity to gain an informational advantage.
Second, the team has a decentralised investment idea generation process, whereby nine portfolio managers utilise their regions of coverage and investment speciality to identify positions they believe will have a high probability for a positive return, and for which the estimated return compensates for the perceived risk.
Most importantly, the portfolio managers are assessed based on individual coverage area performance. Finally, the investment team has operations personnel dedicated to lowering transaction costs and improving liquidity, which generates measurable operational alpha.
Why should insurers consider investing in emerging markets?
Emerging markets debt typically delivers three benefits: better diversification, enhanced returns and improved income. Emerging markets risk is ultimately driven by country-level fundamentals that are separate from the developed markets assets most insurers own, thus providing a diversifying source of returns.
Emerging markets, by definition, are riskier places than developed markets, and there is the potential for spread compression and currency appreciation in emerging markets to boost returns above simply collecting high yields.
Those yields themselves are often much higher than what is available in developed markets, thus aiding near-term cash flow requirements, and compensating insurers for the risk of holding emerging markets assets throughout the investment holding period.
What makes MSIM's 1GT private equity platform innovative, and what are its climate objectives?
1GT is seeking to invest in companies that will collectively avoid or remove one gigatonne of CO2-equivalent emissions from the earth's atmosphere from the date of the platform's investment through 2050. This is the date by which the United Nations has mandated "Net Zero" must be achieved.
We believe we need to radically alter the traditional model of private equity impact investing in three ways. First, we need to seek climate goals that are tangible rather than anecdotal, and ambitious rather than tangential.
Second, in order to catalyse meaningful progress in climate solutions, a significant portion of financial incentives should be linked to such climate goals. Third, the measurement of those goals should be transparent to limited partners. With our 1GT goal and linked financial incentives for the team, we have endeavoured to do just that.
How does MSIM's multi-asset investment approach stand out?
MSIM's Global Balanced Risk Control (GBaR) investment team has an established approach to managing globally diversified multi-asset portfolios targeting stable risk, and is closely aligned with the dynamic objective setting of insurers. The GBaR investment process seeks to maximise returns, while actively managing total portfolio volatility and incorporating Solvency II constraints, to allow for clients' changing risk management and solvency capital requirement (SCR) criteria.
A key differentiator is its starting point: a risk target, volatility or value-at-risk (VaR). There is no traditional benchmark and the portfolio managers, in co-operation with MSIM's insurance solutions team, dynamically manage insurance portfolios, seeking upside participation and to mitigate the downside. With a customised SCR limit, clients can retain control of capital budgeting and this is neatly aligned with Solvency II governance, risk oversight, and capital control.
What is your outlook for the multi-asset investment space in 2023?
We see 2023 as a year of transition, with several likely opportunities in the first half, but also fat-tail risks. Though US inflation is moderating, the greatest risk we see is the potential for inflation to re-emerge in the second half of 2023, which could happen if the Federal Reserve stops raising rates too soon. In the meantime, we anticipate that moderating inflation and a strong labour market are likely to continue to support consumption.
Factors driving markets in 2023 appear to be behaving in the opposite direction to 2022. Falling inflation, central banks ending their tightening cycles, the US dollar stabilising or even weakening, and China reopening indicate the outlook in 2023 may not be as bearish as many anticipated.
