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'Inflection point' approaching for long-term investors, says MSCI

This year could mark an “inflection point” for long-term investors, according to researchers from MSCI.

Investors are likely to be tested by macro events this year, but these tests could prove beneficial to advocates of a long-term approach, wrote Linda-Eling Lee, global head of environmental, social and governance (ESG) research, and Matt Moscardi, head of financial sector research.

“Since the global financial crisis, a growing chorus of investors and policymakers has railed against short-termism and advocated taking a long view,” the pair wrote in an outlook report.

“With more upcoming elections showing potential signs of populist political shifts, the temptation will be to react and over-react to spasms in the Twittersphere. But what 2016 taught us is that it’s the slow-burning risks that can matter the most.”

Asset owners cannot afford to ignore such risks as they “own both outcomes”, Lee and Moscardi said – both long and short term.

A favourable deal for a company on corporation tax may be profitable on a six or 12-month basis, but if it results in government-spending shortfalls, then the wider economy suffers later down the line, they argued.

In 2017, the MSCI researchers predicted the emergence of two approaches to long-termism: new benchmarks that “explicitly incorporate views of the future”, and a shift towards high-conviction, low-turnover portfolios.

“The year ahead has the potential to test institutions and portfolio companies that espouse a long-term orientation,” Lee and Moscardi wrote.

“The temptation to time the market in response to (or in anticipation of) events – real or rumoured – could prove too powerful a distraction for many. But for investors committed to the long term, 2017 may be the year to differentiate themselves from the pack and orient towards future decades.”

Elsewhere in their report, the pair urged investors to pay more attention to the physical risks of climate change than regulation or politics, citing insurance companies as an example to follow.

“The planet does not care about politics,” Lee and Moscardi wrote.

“This is a reality the insurance sector has known for years. Large swathes of homeowners in the US, for example, moved to government-subsidised insurance because private insurers would no longer bear the risks of an increase in the intensity of storms or the rise of sea levels on their own.

“With the first six months of 2016 marking the warmest half-year on record, 2017 could mark the year that investors protect their portfolios against climate risk like insurers to price physical risk in premiums.”

Focusing on water scarcity, the pair explained that similar portfolios could have differing exposures to underlying physical environmental risks.

Comparing two exchange-traded funds tracking high-dividend indices, Lee and Moscardi found that, although the companies in each portfolio needed roughly the same amount of water for their operations, one was more exposed to regions with “high water stress”.

In addition, holdings in agricultural firms “can alter the risk profile of a fund dramatically”.

Lee and Moscardi found one fund with holdings that required “less than 6,000 cubic meters of water per dollar of sales to operate”, but “an additional 42,000 cubic meters of water inputs to generate those sales”.

The researchers concluded: “In 2017, institutional investors may begin to build portfolios that aim to protect against physical risks that transcend political regimes. While water scarcity may be a starting point, investors broadly are more likely think like insurers in protecting their assets in the coming years.”

The full report is available here here.

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