What is a megatrend? Most institutions share a common belief that megatrend dynamics will result in multidimensional transformations across society, technology, economics, environment and politics (STEEP). We would also strongly encourage this thinking about megatrends to be framed within the context of an integrated system of real-world powerful forces altering the structure of economies, industries and global capital markets.

Importantly, these megatrends can all be defined by intuitive and practical key economic indicators. As such the impacts of these megatrends are identifiable in terms of how they change businesses, the financial system, and society and the environment.

Many long-term investors understand the problem they face in moving towards more sustainable portfolios. They know that basing their investment decisions on historical information alone is sub-optimal, because the relationships and correlations of the past may be wildly different in the future. Moreover, financial asset prices are arguably driven by shorter-term factors and may not reflect the influence of long-term change.

Megatrends matter. More than 80% of respondents agreed that incorporating notions of megatrends into their investment processes was consistent with their beliefs. Moreover, they expect megatrends to exert an accelerating influence on financial and social outcomes over the coming decade.

A good number of investment institutions have developed a set of sustainability beliefs and some have excluded or selected securities based on their ESG characteristics. But integrating sustainability metrics into portfolio management, right down the investment value chain is something we believe has eluded most institutions to date. The difficulty of exploiting the likely premium from long-term investment was cited as a critical barrier to megatrend integration. This gets right to the heart of the problem. That is, how can investment institutions create a truly sustainable portfolio and how can they be sure they have succeeded?

It ought to be possible to do this. While institutional investors have differing taxonomies and cultural challenges, their key decision-making issues tend to be similar, whatever their size and wherever they are based.

This report sets out to lift the financial industry’s awareness of megatrends and highlight our key findings. A second phase report will set out detailed trend-by-trend analysis and results.

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    Responding to megatrends: Investment institutions trend index 2017

    December 2017

Section one: Technological advances

Technology is everywhere. An insight that was backed up by our survey participants — technological trends were rated as the most important on our composite score.

Despite fears that the ‘low hanging’ advances are behind us technological progress continues to drive productivity improvements and at its best can enhance the world’s ability to achieve sustainable and inclusive economic growth and development. In terms of sub-trends, we concentrate on four areas of progress: digitisation and the Internet of Things; automation and artificial intelligence; new Fintech; and biotechnology and personalised medicine. We also highlight the potential disruptive capacity of cybersecurity and privacy risks.

Respondents from all backgrounds were particularly concerned about the impact of cybersecurity risks, which was our top rated sub-trend. Other technology sub-trends were also rated highly highlighting the continued importance of technological progress in driving economic growth and its increasing use in financial services.

Section two: Environmental challenges

Our environment impacts all aspects of our activity. We highlight three areas of key change over the coming decade. First, the rise of acute environmental events such as hurricanes and typhoons. Data from the National Oceanic and Atmospheric Administration shows that the prevalence of ‘billion-dollar’ insurance losses (on an inflation adjusted basis) increased by 3.5x from the 80’s to the last decade. Secondly, the chronic impact of global warming – heat stress, water stress, extreme rainfall, and sea-level rise. Finally, a large scale transition to a low carbon economy has the potential to mitigate some of the largest impacts of rising global temperatures.

Section three: Globalisation and connectivity

Since 1950 global trade has grown at a faster rate than GDP growth, culminating with China’s accession to membership of the World Trade Organisation in 2001. We believe that this expansion has reached its peak and trade growth will slow. However, capital market integration and data flows are and will continue to become more important. Global market integration and the floating of currencies led to an explosion in capital flows between 1990 and 2007. With the opening up of China’s capital markets we expect this trend to continue. Finally, we also expect a third globalisation/ connectivity revolution in data flows.

Section four: Society and demographics

The material decline in fertility rates and increases in longevity over the past century are well known to investors. When combined with accelerating societal trends, such as wealth and income inequality and rising public sector debt burdens, demographic shifts have the potential to drive material transformation. We highlight the likely slowing of economic growth, human capital pressures, rise of populism and conflict, changing consumption patterns, savings conundrum and public sector debt burdens as material sub-trends.

Section five: Emerging economy growth and dynamism

The recent slowing of economic growth could be taken as a sign that the dynamism of emerging economies is waning. However, concentrating on headline GDP growth numbers is a mistake, we are long past the point where emerging economy growth supports over half of global economic progress. Led by rapid urbanisation, emerging economies will continue to become more influential, with increasing consumer power and expanding corporate competitiveness. Rising geopolitical power will be exerted via new institutions and governance, especially exemplified by China’s One Belt, One Road policy.

Section six: Analysing megatrends as a system

Viewing the economy, the firms of which it is comprised and its financial systems as ecosystems has gained popularity in recent years. Over time economies and financial markets have become more interconnected such that this change in perspective, from considering how a single individual firm might compete to thinking about the system as a whole, is a natural progression. We believe this approach allows better assessment and management of risks faced by individual organisations as well as systemic risks. As the Generation Foundation highlight, “a systems view of megatrends reveals the interrelation of several sustainability issues, which broadens the set and complexity of second order risks and opportunities for investors.” In particular those risks that might be described as the tragedy of the commons — where the self-interested actions of individuals leads to the demise of the group – come into focus and we can begin to consider how pressures both within the investment system and applied from outside will shape how it changes over time.

We capture the benefits of applying systems thinking through three principles:

  • Our approach is bottom-up – businesses are the primary domain through which social and physical technologies will be adopted. Trying to link trends directly to outcomes solely through a top-down approach lacks credibility given the scale of uncertainty.
  • We deal with decision-making under uncertainty through the use of scenarios, e.g., business-as-usual and 20C scenarios for climate-related trends. Microeconomic cost-benefit analysis is used to identify – and estimate where possible – material shifts in industry economic costs or benefits and societal value.
  • We focus on practical outcomes, i.e., we identify the barriers that may prevent a scenario from being realised and whether these are changing.

This framework resonates well with the concept of “what gets measured, gets managed” and is an input to boards setting long-term strategy, portfolio managers dynamically seeking out the best investment opportunities, and policymakers assessing financial stability or the world’s ability to meet the Sustainable Development Goals.

For example, integrating climate and natural disaster risks and resilience into the financial system presents the opportunity to help save millions of lives and livelihoods in the coming decades and to protect billions in assets and property in a cost-effective and rational way when weighed against competing priorities. We can link the combined power of different stakeholders in the system, e.g., financial regulation, financial disclosures by businesses, and the techniques of the insurance sector for measuring the 1:100 / 1:20 year natural hazard risk and average annual loss across exposed sectors and industries. This relatively simple solution would deliver significant progress in natural disaster resilience at the local and global scales, and across public, private and mutual sectors for both short and longer time scales.

Our framework, we hope, deepens our collective understanding of the long-term generators of and detractors from the sustainability of financial investment, the financial system, and economic development.

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    Responding to megatrends: Investment institutions trend index 2017

    December 2017

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