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The investment case for banks – a bondholder’s perspective

As the world wakes up to the new reality of extremely slow growth, there seems little doubt the returns investors became accustomed to during the ‘Great Moderation’ are a thing of the past, according to Saker Nusseibeh, Chief Executive of Hermes Investment Management.

We believe investors will need to adjust expectations downwards across almost all asset classes in the future, with real returns of 4-5% not unimaginable. Real yields on government debt may struggle to exceed 1-2% at the same time. While investors can receive a premium for corporate instruments, these are likely to experience rising default levels.

It is clear we need to change the way we think about investing. While it is imperative we adopt a long-term mind-set, we must also incorporate notions of responsibility and stewardship into our actions. If we chase an outcome at the expense of the society we inhabit, then these returns serve no real purpose.

Thankfully, the assumption investors would have to sacrifice returns for pursuing positive social and environmental change has long been dismissed. The good news for investors today is there are many long-term sustainable thematic opportunities to explore – in areas such water, urbanisation and cybersecurity.

Water scarcity a major risk to society and global growth
A recent CDP report found water insecurity to be the largest risk to our society as a whole – with failure to manage this scarce resource challenging the economic prospects for countries and overall global growth. Corporates will need to include water management in strategy and investment planning, as well as risk management and mitigation. The good news is leaders are already emerging, with pragmatic water stewardship offering clear benefits to companies.

For investors, a long horizon of opportunities exist in this space – in areas such as water utility equities, corporate infrastructure bonds, water treatment project finance and water technology venture capital. In the immediate future, opportunities for investment are in water treatment and recycling, as well as more efficient usage – with the development and deployment of smart meters, surface and groundwater storage and improved irrigation. There are longer-term opportunities in desalination, water-friendly energy and various other technologies.

Despite barely scratching the surface of what we might achieve, it is estimated these areas alone will represent a market north of $1trn by 2020. Water represents a true long-term secular growth prospect.

The multi-decade opportunity in sustainable urbanisation
The conversion of the earth’s land surface to urban use is one of the most irreversible human impacts on the global biosphere. As a consequence, huge demand is being created for private and public sector infrastructure development – in areas such as power stations, electricity grids, water supply and treatment plants, roads, railways, airports, bridges, telecom networks, schools and hospitals. As with water, investment opportunities are prevalent across the capital structure – from micro finance and community development, through to infrastructure and real estate assets.

Today, more than 50% of the world’s population live in cities – a figure anticipated to grow to over 60% in the next 10 to 15 years. There will be limitless opportunities for infrastructure companies, as the urban projects of the next few decades will be financed by a combination of public finance and private contractors. Equity capital, municipal and corporate bonds, project finance, public private partnerships, private finance initiatives and bank syndicated loans will all represent opportunity for sustainable investment.

The rush to urban centres, particularly in emerging economies, is driven by a desire for an improved lifestyle and greater opportunities. Thriving cities must support businesses by providing connections to distinctive talent pools and critical resources. Environmental management must also be integrated into the plan.

We have seen this in the redevelopment of King’s Cross, with the entire area experiencing substantial regeneration, while delivering a healthy return for investors. Developments of this nature represent incredible investment opportunities, with genuinely positive environmental impacts to play out over decades to come.

A new framework required to avoid ‘Cybergeddon’
Cybersecurity affects the lives of corporations and individuals equally – with more than 80 million threats a year, 70% of which go undetected. A potential worst-case ‘Cybergeddon’ scenario has as much as $3trn of global economic value at risk by 2020. To defend against this threat, the $75bn global cybersecurity solutions market is expected to grow by 250% over the next five years.

There are multiple entry points for investors in this theme – with fast growth anticipated in areas such as analytics, automated response technologies, cloud security and biometrics. Investment in critical infrastructure will be a necessity amid concerns over e-commerce payments, encryption, network security and homeland security.

However, this theme does not simply surround products. The threat of IP losses, legal expenses and reputational losses means cybersecurity risk needs to be embedded in the thinking of corporate boards of directors.

Our stewardship group, Hermes EOS, is asking tougher questions on cybersecurity and brings to our attention those corporates best able to protect themselves. However, this issue needs engagement across the private sector and policy makers alike – with a new global governance framework required.

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