Larry Fink just published its letter to investors of 2023. While a large part of the letter is promotional content, it also contains macroeconomic and investment topics and practices that can give C-suites and IROs a view on the risks and opportunities seen by investment managers and asset owners.
Dominoes may have started to fall after a decade of easing policies
The first domino to fall was inflation. Since the financial crisis of 2008, aggressive fiscal and monetary policies have caused inflation to rise to levels not seen since the 1980s.
The possible second domino to fall is asset-liability mismatches. The biggest bank failure in over 15 years in the U.S. occurred last week. Two smaller banks also failed, raising concerns about a potential regional banking crisis similar to the S&L crisis of the 1980s and 1990s (read here for a refresher on that crisis). It is interesting to highlight that Fink thinks that the banking crisis will lead to greater reliance of corporates on capital markets. Banks will become more constrained in lending (reduced risk appetite and stricter capital standards), and corporate treasurers may consider sweeping their bank deposits nightly to minimize counterparty risk.
The third domino that may fall is liquidity mismatches, especially for illiquid asset owners with leveraged portfolios, particularly private equity funds.
Fragmentation of the global economy
Fink highlights that the COVID-19 pandemic has led to greater protectionism, fragmentation, and polarization, eroding trust and hope, and leading to a less integrated global economy. The Russia-Ukraine war further shocked the supply chains. Geographic location will be an additional factor in capital allocation decisions as supply safety remains in focus. While this reshuffling of supply chains benefits national security in the long term, it will be highly inflationary in the short term. Fink believes inflation will stay close to 3.5% or 4% in the next few years.
This new economy of fragmentation brings both risks and opportunities, and Fink thinks North America could be one of the biggest global beneficiaries, given its large and diverse labor force, abundant natural resources, and public policies that help keep chip manufacturing in the U.S.
A "silent crisis" in the making
Rarely mentioned in the media or the political dialogue, Fink observes that retirement planning has become more complex than ever, given the increased longevity of the population, lower market-return expectations, and rising healthcare.
Populations in many countries are aging due to increased lifespans and falling birth rates, leading to smaller working populations and slower economic growth. Prosperous countries and companies must focus on increasing productivity, healthy life expectancies, and labor force participation rates.
To retire comfortably, people need to invest their savings over the long term, which can only be achieved through belief in the financial system, and optimism about the future. Yet, both have been eroded by the combination of Covid, war, political polarization, geopolitical fragmentation, and macroeconomic uncertainties. Fink believes that we will need inspiring political leaders to emerge and institutions to regain their trustworthiness to rebuild people's confidence in investing over the long term.
Navigating and investing in the global energy transition
Although less prominent this year, this is a recurring topic of last year's letter. Fink mentions that all long-term investors need to consider energy transition in their decision-making. In particular, how it will impact the economy, asset prices, and investment performance.
He points out that climate risks have impacted the financial sector as much as other sectors. Insurance costs have risen in response to shifts in weather patterns. In 2022, insurers had to cover USD 120 billion for natural catastrophes (~24% increase compared to the 2017-2022 average). The housing market could see significant changes in the U.S. if people relocate to areas less affected by changing weather patterns.
He highlights that the transition to a low-carbon economy is top of mind for many of his clients. But he remarks that their objectives and processes are different. Some want to invest along a particular transition path or to accelerate that transition, while others choose not to. Some clients focus on investments that can benefit both households and economies, such as infrastructure. Other clients want access to data that can ensure that material sustainability risk factors are incorporated into their investment decisions. Overall, Blackrock watches changes in government policy, technology, and consumer preferences for investment opportunities for their clients. It evaluates the likelihood of future carbon emissions paths, how government policy can alter them, and what that means for investment risks and opportunities. This is why it has advocated for more corporate disclosures and asked corporate management teams to elaborate on their plan to navigate the energy transition.
Regarding investment themes related to energy, Fink mentions three of them: business model transition for established energy companies, emerging energy technologies (e.g., carbon capture and green hydrogen), and transition finance.
Transforming proxy voting
Another recurring topic of Fink's letters is his commitment to promoting shareholder democracy. He reiterates his firm's belief that allowing their clients to vote directly can enhance corporate governance. However, he advises his clients to spend sufficient time and resources to make informed votes instead of fully relying on proxy advisors.
Finally, while last year Fink briefly mentioned digital currencies and the underlying technologies as an area of research, he expressed this year that digital assets are an opportunity for Blackrock. He believes that tokenizing asset classes could bring efficiencies in capital markets and improve cost and access for investors. In particular, Blackrock is exploring areas such as permissioned blockchains and tokenization of stocks and bonds, which are the most relevant to their clients. Fink also reckons that developed markets like the U.S. have lagged in innovation, leading to higher payment costs. In contrast, the digital asset space has seen exciting developments in emerging markets such as India, Brazil, and parts of Africa, where digital payments have advanced financial inclusion and lowered costs.
We hope this article helps fuel your internal discussions and prepare for investor meetings. As usual, you can reach out to analysts and portfolio managers through Irostors. If you are interested, feel free to get in touch with us.
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