CONTRIBUTORS
Kim Catechis
Investment Strategist,
Franklin Templeton Investment Institute
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INTRODUCTION
Powerful “waves” are sweeping away established assumptions, fundamentally altering the economic, political and public policy foundations for asset prices. Our original paper, Deep Water Waves, explores how the biggest “waves”—demographics, technology innovation, debt, taxation, geopolitics and climate change—are set to impact investment outcomes in the next decade. This companion paper examines two relatively underappreciated waves—geopolitics and climate change—to demonstrate the interdependencies between them and identify flashpoints that should be monitored. Together, they warrant urgent attention, as they could have a short-term and direct impact on the cash flow generation and rate of growth of investee companies, as well as the strength of sovereign financials in many countries. These impacts imply the restriction of valuation potential and hence investment returns for all asset classes.
Deep Waves in Practice
Learn how some of our managers are thinking about climate change
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. There is no assurance any forecast, projection or estimate will be realized. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector—prices of such securi¬ties can be volatile, particularly over the short term. Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.