To have success in the post-downturn capital markets, institutional investors will have to reflect not only past investment strategies and asset allocations but also on the lessons that history has taught.
Those were two of the broad messages presented during Northern Trust's 2010 Institutional Client Conference. The three-day event – "Reaching for the New Gold Standard of Investing"– attracted more than 300 attendees who heard presentations on topics ranging from effective risk management strategies and global retirement plan trends to the impact of financial reforms on derivatives and opportunities within emerging and frontier markets.
In a keynote session entitled "Looking Forward: Investing in the Post-Crisis Environment," Bob Browne, chief investment officer at Northern Trust, encouraged investors to carefully re-examine all aspects of their investment processes.
"Risk needs to be defined not just in terms of the risk of losing money, but the risk of underperforming any benchmark," Browne said. He also noted that the asset classes in investors' portfolios might no longer be serving the same role as they had previously. "Something you have to think about as an investor is that asset classes themselves, their very nature changes over time."
Browne's co-presenter, Jim McDonald, chief investment strategist at Northern Trust, added that investors might have to broaden their horizons in order to identify attractive investment opportunities.
"More than 50% of global growth over the next five years is going to come from countries that don't have budget deficit problems," he said. "This is something that to us underpins one of our longer term themes, which is an orientation toward emerging markets."
A broader perspective will be needed not just geographically, but also when looking within specific asset classes, McDonald explained. Within fixed income, for example, he said investors might want to consider high-yield corporate and high-yield municipal bonds to offset the low nominal yields on investment-grade bonds.
"It has to be very well diversified and it has to be very well researched … but we do think there is a liquid and large market in both high-yield corporate and high-yield municipals to help supplement some of the low nominal investment-grade yields today," McDonald said.
Another session, "Winners and Losers – Coming Out of the Economic Downturn," outlined the similarities and key differences between today's environment and the economic downturns during the 1930s and 1970s.
"In the same way that we went through a housing bubble over the last 10 or 12 years, there was of course an equity bubble during the 1920s," noted Leo Abruzzese, editorial director, Americas, at the Economist Intelligence Unit.
An important difference between now and the Great Depression, however, is how the Federal Reserve Board is using monetary policy to address the economic climate. Abruzzese noted money supply contracted by about one-third between 1928 and the early ‘30s, whereas today the Fed is trying to pump as much liquidity and cash into the financial system as possible.
The session's other speaker, Paul Kasriel, chief economist at Northern Trust, said that although the Fed's initial efforts did not have the desired effect, the second round of quantitative easing should be more successful.
"What happened in this past recession was that we saw the largest collapse of commercial bank credit in the post-war era," Kasriel said. He added that in only one year between 1946 and 2008 did commercial bank credit contract, and the contraction in 2009 contributed to the depth and duration of the recession.
"In my view, in effect what's happened is the monetary policy transmission mechanism has been broken," he said referring to the role of the commercial banking system in conveying the Fed's monetary policy to the rest of the economy. "The Federal Reserve monetary policy engine was revving at a very high rate, but those revolutions were not being transmitted to the wheels of the economy because the banking system was broken."
The good news, Kasriel said, is that there was a modest increase in bank securities beginning in the third quarter and that banks appear to be easing their lending terms.
Additional session materials and videos are available on Northern Trust's website.