In recent months, the clouds over the world economy have rapidly darkened. Although unemployment is low in both the US and Europe and wages are rising faster than before the coronavirus crisis, consumer purchasing power has begun to decline as rising prices eat away at all income growth and more.
Due to bottlenecks in supply chains, suppliers of goods and services are unable to meet demand. Therefore, companies are trying to bring the production process closer to the end market and expand the choice of suppliers. The seeds of deglobalisation were sown even before Trump’s election victory and Brexit. The ongoing coronavirus crisis and the current war in Ukraine have sharply accelerated this trend.
At present, no one has definite answers to questions of how stormy the economic environment will become, how long the bad weather can last, and whether there is anywhere to hide.
How to survive the storm?
Should we take money out of our pension fund and spend it, as suggested by ostensibly economically conservative politicians who abolished mandatory pension contributions, or, on the contrary, put aside more money now than before, because no one knows how long the global economic storm will last?
Life has taught me that those who have built up reserves, have a strong balance sheet (little credit) and are able to control their own expenses, can cope better in difficult circumstances. They have the ability to seize the opportunities that difficult times can offer.
The economic recovery cycle from the bottom of the 2008 economic crisis to the 2020 coronavirus crisis was the longest in history. Behind this long rise was the low interest rate policy pursued by the world’s largest central banks, which made both investors and consumers overconfident. The investment world saw the development of the YOLO (‘you only live once’) investment strategy, which was used to justify taking huge risks. A similar mentality could be seen behind consumer behaviour.
The world is full of paradoxes: circumstances and things are often not what they seem at first glance, and actions and decisions can have unforeseen consequences. These are the three principles by which I have sought to make sense of investing throughout my 30-year investment career.
While in the wake of the 2008 financial crisis, there was a debate about why pension fund investment strategies are too risky, the last five to six years have been characterised by a concern that pension fund returns are insufficient. People have asked why there has not been more risk-taking.
At the time of the creation of the funded pension system in 2002, pension funds were seen as reserves that each person gradually accumulates from their regular income over their working life and which they will use after they retire.
Reserves and liquidity buffers are different things and are designed to solve different problems. For me, reserves are something that are carefully kept and protected so that they exist in the situation for which they are accumulated. As a pension fund manager, I have invested the assets of my clients following the principle that it is more important to have assets that are well kept and that would maintain purchasing power even after adjusting for inflation, than getting maximum returns.
Active cultivation of assets
LHV’s pension fund investment strategy has been much more conservative in recent years than before, but it has not included holding large bond or cash positions. Instead, we have sought out investments whose value would be determined by cash flows and not by investor sentiment, whether optimistic or pessimistic.
For the LHV team, active investing does not only mean that the fund manager selects shares on the stock exchange themselves, as opposed to passive investing, in which the equity indices in which to invest money are determined by an algorithm. For LHV, active investing also means looking for investment opportunities outside the stock exchange and, where possible, creating them ourselves.
For example, in the field of real estate investments, active investment for us also means applying for building permits and engaging in development activities. When it comes to investing in local bonds, active investment for us means thinking through the financing of the entire company and requiring guarantees to protect our investors.
Active investment also happens when, while making an equity investment together with a private equity fund, LHV’s pension funds become a party to the company’s shareholder agreement. For us, being active means, above all, thinking about how to make something better in the company or project in which we are investing. For us, active investing means much more than deciding when is the right time to buy or when to sell.
The importance of a clear head and self-discipline
I suspect that in a situation where the prices of raw materials, labour and money are rising, companies and projects with a high debt burden will face more difficult times than before. This means that cutting costs and focusing on profitability is becoming increasingly important.
Just like companies, individuals should also review their balance sheets: how many assets are there, and how much and under what conditions have loans been taken out against these assets? While the fear of inflation may make it seem tempting to acquire increasingly ‘scarce’ real estate, one should also consider the possibility that rising interest rates may turn real estate obtained using a large loan into a liability.
I hope that politicians around the world will also have the statesmanship to refrain from pandering to voters and allowing for more and more subsidies to help the people cope with the inflation that governments themselves have created.
In difficult times, those will fare better who can keep a clear head and look beyond tomorrow when setting their targets and goals.
In recent months, the clouds over the world economy have rapidly darkened. Although unemployment is low in both the US and Europe and wages are rising faster than before the coronavirus crisis, consumer purchasing power has begun to decline as rising prices eat away at all income growth and more.
