In a paper Macro factors – the update, released today, the firm describes how these so-called macro factors themes cut across asset classes and investment managers and can have a substantial impact on asset returns.

 

Tim Hodgson, senior investment consultant in Watson Wyatt’s Thinking Ahead Group, said: “Early mover advantage is key as is a thorough understanding of the timeframe in which a macro factor idea evolves as an investment opportunity.”

 

In the paper, the firm updates its view of these macro factors, which it first identified in 2005 in order to assess their impact on global equity returns in the coming decade.

 

Tim Hodgson said: “A few of these macro factors now dominate the investment landscape, mainly as a result of the financial crisis that began with the US sub-prime problems in 2007. While our 2005 outlook was more focused on demographics and emerging wealth, public policy and geopolitics have now become priorities on the investment agenda.”

 

On the public policy theme, the firm notes the difficult balancing act between competing threats of inflation and deflation. It concedes it is difficult to have a central view on the outlook for inflation and deflation, because of the dependency on the relative strength of the deflationary forces and government stimulus efforts. However, it suggests there will be very low inflation in the short-term, but with the prospect of significantly higher inflation further out.

 

Watson Wyatt also highlights geopolitical trends because they have many linkages with public policy in any attempt to revive the global economy. It suggests protectionism is at the forefront of the geopolitical landscape, as governments seek to boost domestic employment levels and domestic industries. In the firm’s view, protectionism is bad because it can undercut the effectiveness of policies to boost aggregate demand and restore sustained growth globally. Furthermore it suggests financial isolationism, a new type of protectionism resulting from the government involvement in banks, also has a negative effect.

 

Tim Hodgson said; “Another important geopolitical issue for the future is competition for resources. Most attention is given to energy and materials, but we believe food and water could be surprising sources of conflict in the future. ”

 

According to Watson Wyatt, there are two methods of accessing exposure to macro factors: beta-type and option-type. Beta-type opportunities require constructing an index that reflects the macro factor or by using existing indices. In option-type implementation strategies, there are two ways to create option style pay-offs. The first is by overlaying options added to existing investment portfolios or through embedding optionality created by mechanistic stock or sector level rebalancing strategies. The second is by combining individual stocks and related listed options into a portfolio.

 

Tim Hodgson said: “The macro factors outlook is very uncertain, but a careful focus on public policy and central bank measures is helping to navigate the turbulent waters of a post-financial crisis world. Therefore, investors with high governance have the opportunity to exploit particular macro factors where they have strong views. However, it is worth noting that the main challenge, as ever, is in determining how much of the story is already in the price.”