As 40-year tailwinds turn to headwinds, we distill an era of sometimes bewildering change into three themes and a new investment playbook.

The global economy and financial markets have benefitted from several significant tailwinds over the past four decades. Inflation moderated and stabilized, giving central banks greater policy flexibility; global interest rates declined; geopolitical tensions eased during the 1990s, creating the conditions for the efficiency gains of globalization; labor markets lost pricing power and grew more flexible; corporate tax burdens lifted; natural resource- and fossil fuel-intensive growth raised living standards and generated investment opportunities worldwide. It was a particularly golden era for investors in fixed income securities, technology and other “long-duration” assets.

Many of those tailwinds are now turning to headwinds, and we believe this demands a new investment playbook. Here, we distill an era of sometimes bewildering change into three themes for managing risk and seeking return opportunities in the new regime.

Our Three Themes at a Glance

OUTLOOK: Adapt to Today’s New Challenges

Two multi-decade economic tailwinds are under threat. Globalization is hitting geopolitical, strategic, populist and practical roadblocks, and unsustainable growth powered by fossil fuels faces a difficult transition to ultimately more efficient growth powered by renewables.

Potential economic implications:

  • A return to structurally higher inflation and more hawkish central bank policy
  • A return to shorter and more volatile business cycles
  • A global energy transition

Investment playbook:

  • Favoring the fittest
  • Rethinking regional risk
  • Harvesting global macro trends, tactical dislocations and volatility premia
  • Accounting for “Net Zero”
  • Prioritizing real assets: Commodities, real estate, infrastructure

RETURNS: Mind the Gap

Lower and more volatile growth, together with higher inflation and interest rates, could slow the performance of many equity and bond indices, opening a wider gap between targeted returns and return outlooks. This “exhausted beta” phenomenon, together with the potential for higher price volatility and an upward bias in rates, is likely to make return profiles more reliant on income, illiquidity and niche-market premia, as well as active management (asset-allocation, stock-selection, corporate engagement and operational “alpha”).

Potential portfolio implications:

  • Lower asset class return outlooks, with higher volatility

Investment playbook:

  • Looking beyond “exhausted beta”
  • Going short as well as long
  • Rebalancing toward value investing
  • Becoming fully flexible in fixed income and credit
  • Prioritizing income across asset classes
  • Integrating public and private market investments
  • Exploiting your natural advantages while seeking effective partners

RISK: Diversify Differently

Higher volatility and economic uncertainty, as well as the use of increased portfolio risk to align return profiles with return targets, make portfolio diversification more important than ever. Diversification could be more difficult to achieve, however, as equity-bond correlation tends to rise in more inflationary environments.

Potential portfolio implications:

  • Higher equity-bond correlation leading to higher portfolio volatility

Investment playbook:

  • Adding flexibility and shortening duration in fixed income
  • Seeking out uncorrelated markets and strategies
  • Prioritizing inflation-sensitive real and financial assets
  • Identifying and hedging the tail risks that matter to you
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