2024 EMEA Investor Forum

2024 EMEA Investor Forum

A changing investment paradigm for asset owners

“We need to think that the past is no longer a good guide to the future. Narratives and trends that were there for years have been stood on their head, and we need to look at things afresh.” Katharine Neiss, Deputy Head of Global Economics and Chief European Economist, PGIM Fixed Income

Until recently, the period since the global financial crisis was almost a false economy in which low interest rates drove asset values. That is changing. For example, the past two decades have been about sector bias in real estate. But it has now pivoted to geographies and the importance of different cities as economic drivers. As society ages, productivity matters more; therefore, capital allocations must be made accurately to boost productivity.

The conventional narrative for Europe is that the bloc is saddled with too much debt. But that is no longer the case. The debt-to-GDP ratio for the region’s peripheral economies—traditionally a concern for investors—is lower now than before the pandemic. Europe’s new challenge is the weakening growth outlook in the core economies such as Germany. 

The broader concern for Europe to stimulate growth is not a lack of money as they have the fiscal means but the fiscal infrastructure and political choice to implement key facets of the Mario Draghi report. The region needs deeper capital markets and more private capital. That is only possible through deeper financial integration. The two main obstacles are concerns about more significant financial risks and loss of sovereignty. However, the rewards greatly outweigh the risks, as investors have always welcomed any pan-European integration news.

Shifting Dynamics in a Multipolar World

“For the EU, I like the sheet music, but the EU hasn’t formed the band, found the instruments, and is not playing in harmony yet.” Taggart Davis, Vice President, Government Affairs, EMEA

The global economy has moved into a multipolar environment, making it difficult for investors to assess geopolitical risks. In our 2024 risk report, about 56% of institutional investors, representing $9 trillion of assets under management, say the threat level from geopolitical risk is high over the next 24 months.

Europe is particularly exposed to these changing dynamics. The U.S. has become an unpredictable trading partner, and the risk of escalated U.S. and China tensions leaves Europe vulnerable. In response to a likely escalation in tariffs, Europe may adopt a more protectionist approach in its trade policy. 

However, the underlying trend of geopolitical realignment doesn’t have to be harmful, and there could be potential winners and losers. Long-term investors shouldn’t be too obsessed with the impact of geopolitical risks in the short term, as the effect on asset prices tends to fade over long periods. However, investors should be wary of when a regional political event or conflict can spill globally into the broader financial markets. 

Investors should strive to stay with resilient and diversified portfolios. While geopolitical risks cannot be easily hedged with financial instruments, asset owners could take a more strategic view of their portfolios and allocate suitably to defensive assets or companies with resilient supply chains.

Opportunities for investors as Private Markets take centre stage

“Anytime you have gone through such an increasing pace of asset adoption, the so-called golden age of credit, mistakes will be made..” Matthew Harvey, Executive Managing Director and Head of Direct Lending, PGIM Private Capital

The flow of institutional capital into private markets has grown exponentially in recent years. A research study of institutional investors in Europe and the Middle East representing assets of $10 trillion under management found that respondents have invested 25% of their portfolios in private alternatives.

In private equity investing, a broader trend towards mega funds will continue due to capital efficiency and lesser complexity in managing various relationships. Large asset allocators gravitate towards established brand names due to better processes and regulatory frameworks. Moreover, from a capital deployment perspective, larger firms have a global reach, helping them pivot across markets. However, bigger private equity firms face challenges due to higher borrowing costs and fewer exit options.

A higher for longer interest rate environment has resulted in increased returns for direct lending investors. However, it has also caught the industry off guard, with the rate-tightening cycle leading to higher interest costs for leveraged balance sheets, resulting in a significant drain on cash flows and weaker credit metrics. However, due to relatively tighter covenants, direct lending strategies are quicker to avert default. Manager skills are essential to driving recoveries, and larger asset managers have greater expertise.

In real estate, declining interest rates has resulted in a bottoming out of valuations. However, the recovery will be nuanced as investors focus on rental and income growth. Changes in lifestyle patterns, from students to families and older people, are key valuation drivers. 

Uncovering opportunities in an uncertain fixed-income market landscape

“We are seeing a broadening of the investor base from insurance, pension and retail participants. Many investors weren’t too familiar with the asset class. There has been a resurgence as they seek to diversify away from corporate credit.” Gabe Rivera, Co-Head of Securitized Products, PGIM Fixed Income.

The global securitised market is worth around $5 trillion and touches the broader economy, ranging from consumer loans to residential real estate. This asset class comprises asset-backed securities, commercial mortgage-backed securities, CLOs, and residential mortgage-backed securities.

With corporate spreads near record levels, fixed-income investors are wary of owning duration in the current stage of the economic cycle. Securitised products offer investors the opportunity to own spreads at a higher level of the capital structure with attractive risk-adjusted return profiles.

At current spread levels, against the backdrop of rising geopolitical risks and uncertainty, securitized products offer a higher income with lesser spread durations. European “AA” CLOs offer value.