Sunday, January 10, 2010

Investing for wealth: Themes for next decade

Each of the last few decades has presented thematic investment opportunities that have been quite unique. The first decade of the new millennium was similar, yet different as markets were tumultuous both at the beginning and the end of this decade. Here’s an attempt to provide some investment themes that could provide significant opportunity over the next decade.

Energy: The International Energy Agency (IEA) released its World Energy Outlook in late 2008. The IEA estimates that every fossil fuel resource we rely on today will simply not be able to keep pace with demand. Coal reserves are expected to be over in less than a 100 years; natural gas production is expected to go into a decline after 2020; and uranium mines will not be able to keep pace with demand, and current oil production from a majority of oil fields are past their peaks and beginning their decline.

The next alternative to traditional energy is alternative energy or renewable energy. Whether it’s solar, wind, photovoltaic, geothermal, bio-fuel or hydropower, these alternative sources of energy will gradually replace more conventional sources.

Commodities: Recent money supply growth with central banks around the world printing money, higher inflation is likely to stay for some time. In this scenario gold, silver and other commodities are a good destination.

Developed economies such as the US, France and Germany have over 65% of their forex reserves in gold. On the other hand, Bric countries and other South-east Asian economies have less than 5% of reserves in gold. Over time as their levels go up, gold prices will be driven higher. Fertiliser and food-grain will also remain attractive through the decade as we try to feed the world’s growing population and combat the decline of oil with biofuels.

Infrastructure: Whether its roads, power, ports, internet telecommunication or water supply, not many will argue against the notion that there is huge need to increase infrastructure spending in India. As per estimates, India may require $1.7 trillion in the next decade starting 2010 to meet its infrastructure demand. In addition to primary infrastructure, this will create demand for ancillary industries like construction equipment, mobile phone providers, etc.

Other themes: Clean freshwater would be in demand since there is water shortage expected throughout the world. Biotechnology & healthcare would be a big play since these sectors would produce drugs for curing many of the new diseases we are continuing to discover. Nanotechnology, the science of building machines on an atomic scale, promises ways to make many products lighter, stronger and cheaper. Nanotech has already done that with clothing, cosmetics and even golf clubs, but it could make a real difference in building materials, communications equipment and medicine.

Emerging to Developed: Compared to the West, the East is entering 2010 on a firm footing. Currently the size of Asia ex-Japan’s output remains modest relative to the world economy (GDP of China, India and Asean-10 is $7 trillion compared to world GDP of $61 trillion). However, the world’s population is set to soar 50% over the next 40 years, mostly from emerging markets. With favourable demographics and relatively low levels of consumer debt, emerging markets are expected to generate most of the world’s economic growth and account for nearly all additional demand for natural resources.

Capture opportunities

It can be easy to get distracted with the diversity of investment ideas. Yet, prudent investors must stay focused on long term investing, and the time-tested benefits of an efficient asset allocation will continue to prove a smart strategy for building wealth. Depending on how comfortable you are with risk, you should choose an appropriate combination of assets that can help you optimally benefit from the growth opportunities over the coming decade.

For individuals in the early part of their career — say mid 20s to mid 30s — with a steady and growing cash flow in the years to come, a greater portion of risky assets should be preferred. You could limit cash exposures (risk averse assets) and keep enough aside for contingency needs. An allocation high in equities — local as well as international followed by deposits, gold & alternative assets and money market funds will provide a suitable portfolio to such individuals.

A middle aged person could gradually curb exposure to risky assets (depending on his/her risk tolerance) and start keeping a higher portion in assets with lower volatility viz. deposits/bonds and money market funds. Likewise a person with little inflow of cash, e.g. a retired individual would require regular income with low volatility and high safety of capital. An allocation to equity and other risky assets should be limited (though not zero) with a higher allocation to money market funds and fixed income products.

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