How to build a resilient investment portfolio in uncertain times

The year 2023 was filled with unexpected developments. Despite widespread predictions of a global recession, the economy defied expectations. Geopolitical events caught many off guard, particularly the outbreak of conflict in the Middle East.

Meanwhile, the enthusiastic adoption of artificial intelligence (AI) sparked a significant rally in the US stock market. Climate records were shattered, with 2023 becoming the hottest year on record and experiencing the fastest sea level rise. Extreme weather events caused widespread disruption across all continents.

Uncertainty is a given for any investor but events in the past few years have intensified it to a profound level, challenging the foundational assumptions of the past four decades. The world order is being reshaped, domestic politics in several large countries are in a state of flux, rapid technological changes are buffeting societies and the effects of climate change are becoming more intense and unpredictable.

It is no longer sufficient for investors to consider only where we are in the macroeconomic cycle or the future path of interest rates. National security concerns, politically driven regulations, climate impacts and policy and more must also form part of the calculus. This unprecedented uncertainty translates into a broader range of possible outcomes. Pitfalls and windfalls await in equal measure.

No maps exist to help investors navigate this uncertain terrain. Old theories and typical models do not capture sufficient history – mean reversion, which dictates that cyclical variables, such as valuations or margins, return to the average value over time, is less certain and precedents are few.

To navigate the unknown, investors should instead rely on two things:

For a long-term investor such as GIC, this means doubling down on our principles of price discipline, a granular approach to diversification, and our strengths, such as our long-term, flexible capital.

Price discipline is a core part of a long-term investment approach because it delivers steady compounding of the total portfolio returns. Despite fluctuating macroeconomic and geopolitical conditions, certain markets have yet to price in the level of uncertainty investors face. Instead, many are primed for a Goldilocks – “not too hot, not too cold” – economy. It is a plausible scenario but only one of many.

Risk premia, the extra return expected over the risk-free rate, is low in various markets like credit and equities. This suggests that investor confidence might not match the actual risks. In this situation, investors need to be careful with their pricing and thoroughly evaluate the risks and rewards of their investments to ensure they are being properly compensated for the risks they take.

AI provides a concrete example. Many early-stage AI businesses command very high valuations, justified only if they are eventual winners. However, predicting the winners and losers is difficult. Hardware makers, including semiconductor firms and infrastructure-layer businesses such as cloud platforms, have less downside, though their valuations have also expanded recently. Each case requires careful assessment of its potential risk-return trade-offs.

Effective diversification provides the best protection during times of uncertainty. However, it is insufficient to only diversify across different asset classes, which most investors already do. Diversifying with far more granularity, particularly in private markets, can provide investors with an edge.

Take real estate as an example. Diversifying into sub-sectors, including data centres, student housing and logistics and different geographies, has helped investors weather adverse macroeconomic and microeconomic conditions, including the recent sharp rise in interest rates and the shift in US commercial real estate.

With uncertainty comes risk but also opportunity. Long-horizon investors’ ability to provide long-term, flexible capital enables them to capture opportunities other investors may overlook.

The climate transition presents a prime example of how long-term, flexible capital can make a difference. Investors now see that financing the transition may involve short-term opportunity costs they are not ready to bear. In 2023, companies in climate tech had to continue raising capital amidst muted valuation levels. Investors saw fewer exits and venture and growth investment in the sector declined 30% from the year prior. The slowdown happened despite the clear, long-term opportunity presented by the energy transition.

The patient capital of long-term investors, including GIC, is well-suited to navigate climate tech’s potential J-curve. Last year, the Sustainability Solutions Group (SSG) in our private equity department identified companies that needed significant capex to scale up “first-of-a-kind” climate tech projects. These early pilot or demo projects, which are past the lab stage but not yet commercially scaled, often fall between traditional capital buckets.

These investments would not meet the return hurdle of venture capital and, at the same time, would lack the track record to attract infrastructure finance. We launched an investment programme for green assets to bridge this funding gap, leveraging SSG’s track record and sector knowledge. Such flexible capital, enabled by a funding mechanism that adjusts for risk, allows us to invest in commercializing such decarbonization solutions.

In a world where uncertainty has shaken the foundations of the investment environment, anchoring ourselves to our purpose and core investment principles while leveraging our strengths will be vital in navigating these unchartered waters.

Learn more about GIC’s investment approach in the GIC Report 2023/24.