It is a well-known fact that the pandemic caused births globally to collapse and that they remain below levels necessary to stabilize population growth. We also know that aging populations place a major strain on pension and health care systems as fewer workers have to support more consumers and retirees.

This graph demonstrates that after rising steadily since the 1980s, the global support ratio, or the ratio of workers to consumers, peaked a few years ago and is projected to collapse to levels last seen during the 1970s.

“After rising steadily since the 1980s, the global support ratio is projected to collapse to levels last seen during the 1970s”

The news is filled with alarmist predictions of the “greying” of European, North Asian, and North American populations, coupled with their dire repercussions. After many years of failed government policy to boost fertility rates (e.g., China lifting its one-child policy), there is a sense among policymakers that there is not much that they can do to encourage people to have more children. Studies show us that as people retire, they save less and spend more. As the pool of global savings decreases, it places upward pressure on equilibrium real interest rates and bond yields. Faced with these prospects, governments are likely to further increase spending to encourage more childbearing. Permanent and/or larger fiscal budget deficits will similarly deplete national savings and push rates higher. These demographic considerations have underpinned one of our most recent fundamental investment calls, the end of the 40-year bond bull market. A major corollary of that thesis is that interest rates have begun a structural uptrend with successively higher highs and higher lows, although they will temporarily fall during recessionary periods.

“The results of a 2019 study suggest that the global population will grow much faster than currently anticipated ”

But what if birth rates will eventually increase on their own despite government policy? What if global fertility rates, instead of further declining, may be bottoming and poised to rise sharply? A 2019 study in the journal of Evolution and Human Behavior by Jason Collins and Lionel Page suggests that our population modeling is incorrect because they use assumptions of constant long-term fertility rates. In their place, the authors introduce a dynamic model incorporating inheritable fertility based on evolutionary biology. Rather than stabilizing around a long-term level for developed nations, fertility rates tend to increase as children from larger families represent a larger share of the population and partly share their parents’ trait of having more offspring. In other words, both cultural and genetic evolution will select for families that wish to have more children. To further clarify, the desire to have more children is as inheritable as height or IQ. As cultural forces have suppressed fertility over the last few hundred years (really since the Industrial Revolution), an ever-growing proportion of people with a higher propensity to have more children will have children. When the environment changes so quickly (since the early 1800s, for example) that existing reproductivity strategies become suboptimal, natural selection responds quickly. Their results suggest that the global population will grow much faster than currently anticipated.

“European and North American fertility rates to rise to 2.46 and 2.67, respectively, above the global averages and against all conventional wisdom given current population modeling and projections”

In their model, without the inheritability effect, the global fertility rate declines to 1.82 by the end of this century, which is below the human replacement threshold. But once heritability effects are factored in, that rate increases to 2.21, well above the threshold. If true, this would have massive global policy implications from climate change to migration patterns to global conflict and even extraplanetary human settlement. And as this chart demonstrates, the effects are most pronounced in the two areas you would least expect: Europe and North America. Their model projects the European and North American fertility rates to rise to 2.46 and 2.67, respectively, above the global averages and against all conventional wisdom given current population modeling and projections. At a recent event, Elon Musk said, “if people don’t have more children, civilization is going to crumble.” He is right. Progress, technology, and network effects work better with higher “n” variables: the more people the better. But we might not have to do anything about it from a policy perspective as natural selection pressures might already be breeding out those of us less inclined to have children. As Dr. Ian Malcolm in Jurassic Park reminded us, “life finds a way”.

Ahmed Riesgo – Insigneo’s Chief Investment Officer

Mr. Riesgo oversees all the company’s research and investment functions. This includes investment strategy, devising and implementing the firm’s global market views and asset allocation, communicating them to its clients and the public, and managing the firm’s model portfolios. In addition, he is the Chairman of the Insigneo Investment Committee.

As I mentioned before, we believe globalization peaked around 2008 and has been slowly but steadily declining ever since the Global Financial Crisis. Moreover, the two most recent global events – the pandemic and the Russian invasion of Ukraine – have only accelerated that trend by exacerbating policymakers’ reliability concerns when dealing with less-than-friendly state actors. Whether they manifest themselves as US shortages of masks made in China during the pandemic or Russia holding its oil and natural gas exports over Europe’s head as it invades European territory, these issues are forcing Western governments to reassess the benefits of the hyper-globalization that occurred during the Pax Americana. In other words, they are realizing that the efficiency of the global supply chain may not be worth the trade-offs in both security and stability. On balance, redundancy and reliability of inputs may be worth the cost to consumers of higher prices. All else equal, globalization is a deflationary force, while de-globalization is an inflationary one.

A corollary to deglobalization may be de-dollarization or the breakdown of the Bretton Woods system where the US dictated the terms of the post-World War II landscape by pinning the US Dollar at the center of the global financial and trading system. The concerns I mentioned around security, stability, and reliability are universally reverberating around the world. Non-western governments are also reassessing the trade-offs. Specifically, they are questioning the desirability of the US Dollar as the global reserve currency. As this next chart suggests, unlike during the Global Financial Crisis, many central banks around the world were net sellers of US Treasuries during the Covid-19 pandemic. This disdain for Treasuries was not limited to foes like Russia but extended to close US allies like Saudi Arabia, the United Arab Emirates, and Singapore. To borrow a Cold War era phrase, even non-aligned nations like Brazil and India sold rather than bought US government bond obligations. In other words, the demand for US Dollars is waning around the world, among friends and enemies alike.

“Unlike during the Global Financial Crisis, many central banks around the world were net sellers of US Treasuries during the Covid-19 pandemic.”

While Putin may have made a grievous mistake when he invaded Ukraine, he may not have been the only one that committed an error in judgment, although he is certainly more obvious. However, the Americans, Europeans, and Swiss may too have committed a major policy blunder, even if a more subtle one that may not be apparent for many years. By freezing the Central Bank of Russia’s foreign currency reserves, the West has announced to the rest of the world that their Dollars, Euros, and Swiss Francs are no good anymore. When the Dollar is weaponized as an instrument of foreign policy, it is reasonable to expect defensive maneuvers.

Of course, the Western retort would be that this sort of pariah status is only reserved for “aggressors” and “enemies.” But in the world of geopolitics, your friend in one generation can be a foe in another. Two current and strident allies of the US were our main enemy combatants in World War II – Germany and Japan.

Eighty years is a long time, but central banks should have the long view when deciding where to place their country’s surpluses. Another issue that looms against the demand for Dollars is the US’s deteriorating fiscal position. American fiscal deficit spending because of the pandemic reached 25% of GDP. In Europe and China, those figures were much lower, 15% and 5%, respectively. According to IMF forecasts, structural budget deficits in the country will average 4.9% of GDP until 2026, versus 2% before the pandemic. Over time, persistent budget deficits will reduce savings and ultimately drive the neutral rate of interest higher. A higher neutral rate, in turn, will push bond yields upwards as well. Even though the move up has been quite dramatic so far this year, look for yields to grind higher over the next several years, characterized by successively higher highs and higher lows. Nothing lasts forever and trends always reverse. This chart shows that US treasury yields peaked in the early 1980s amid Fed Chair Paul Volker’s inflation-fighting regime and have been making successive lows ever since – lower lows and lower highs. Has this 40-year bond bull market ended? We think this may be likely and would position for a reversal of this Reagan-era trend.

Now, let us be clear, we are not arguing that the US Dollar is about to lose its place as the global reserve currency overnight or even suddenly. It is not easy to dislodge the world’s reserve currency because there is a certain inertia to that standing due to positive network effects. The Greenback’s pole position is underpinned by the strength of the US economy, the depth of its capital markets, and the fact that most of the global trade is still settled in US Dollars. As the next chart shows, the level of Dollar reserves has held rather steady over the past five years. In fact, more than 60% of all foreign bank reserves and 40% of the world’s debt are denominated in Dollars. But the most important reason it still dominates is that there is no credible alternative out there currently.

“Now, let us be clear, we are not arguing that the US Dollar is about to lose its place as the global reserve currency overnight or even suddenly.”

The European Union is like the US in terms of economic size and the strength of its financial markets, but the Continent has many structural impediments to attaining dominant reserve status, primarily the lack of both a fiscal union and military power. The UK and Switzerland are both too small as a share of global GDP to seriously consider the British Pound Sterling or the Swiss Francs as alternatives. The Chinese Renminbi is an obvious candidate, but China too has issues that prevent this, namely that the country maintains a closed capital account and it is not freely traded. Indeed, the Renminbi only accounts for 2% of global foreign exchange reserves, despite the country approaching a quarter of global GDP. It Is not surprising to read the news that the Saudis are negotiating with the Chinese to settle oil purchases in the Renminbi, and the Russians surely are accepting it as payment for their energy exports today to circumvent Western sanctions. Yes, it would be premature to signal the Dollar’s demise as it will not yet go the way of the Roman Aureus, the Spanish Real, or the British Pound Sterling until US power wanes significantly from current levels, and that is not likely soon. But we could see a situation where the level of Dollar reserves matches the geopolitical reality we mentioned earlier – the first among many – as the marginal demand for Dollars falls as central bankers continue placing less of their surpluses in Treasuries. In that sense, the most important development over the last few weeks may not be Cold War II, but the first stage of declining Dollar hegemony.

“The level of Dollar reserves has held rather steady over the past five years.”

If this thesis holds, US rates will have to go up to entice further buying of Treasuries as they cheapen. The more likely asset bubble, then, exists not in US equity markets but in its sovereign bond market where real yields are still negative despite the recent selloff. As interest rates grind higher, investors would want to own real assets: rental properties, high dividend compa- nies, farmland, agricultural commodities, and industrial metals. “Old” economy sectors like industrials, energy (both hydrocarbons and renewables), miners, and utilities. As central banks around the world purchase and repatriate as much gold as they can, investors would not want to stand in front of that trend either. The precious metal has the added luster of being an attractive geopolitical hedge and outperformer during periods of higher inflation and lower growth. Owning Chinese government bonds is also an attractive option as that, in our view, remains the most attractive bond market in the world. As more trade and reserves settle in Renminbi, it should keep them well bid and it has an attractive carry. Imagine the flows into that market if global reserves rise from the paltry 2% of current reserves to 5% or even 10%. These levels seem conser- vative in a world where the US has weaponized the Dollar and other countries have taken note.

Ahmed Riesgo – Insigneo’s Chief Investment Officer

Mr. Riesgo oversees all the company’s research and investment functions. This includes investment strategy, devising and implementing the firm’s global market views and asset allocation, communicating them to its clients and the public, and managing the firm’s model portfolios. In addition, he is the Chairman of the Insigneo Investment Committee.

Sustainable and ESG investing

Even if it has been around longer than what inves- tors believe, sustainable and ESG investing has increasingly won over the center stage for investors across the world, with a large number of asset classes becoming more and more available for those investors who aside from getting a return on investment, are looking to generate an impact beyond financial gains. Nonetheless, investors are increasingly concerned about the quality of such ‘sustain- able’ or ‘green’ investments, with terms like ‘green- washing’ or ‘social-washing’ becoming more common.

Today, our goal is to get a general understanding of what sustainable and ESG investing means, how that can be achieved in your portfolios, and what pitfalls may lie ahead. Let’s start by stating what sustainable investing means. Per a Harvard Business School article, “Sustainable investing, also called socially responsible investing or ESG investing, is a means of investing in which an investor strongly considers environmental, social, and corporate governance (ESG) factors before contributing money and resources to a particular company or venture. The goal is to, whenever possible, use investment dollars to promote positive societal impact, corporate responsibility, and long-term financial return.” It is worth highlighting the CFA Institute’s addendum to this definition. It further clarifies that “sustainable investing has broader connotations and is more like an investment philosophy, whereas ESG investing works at a practical level to describe investment mechanics.”.

Despite its current popularity, it should be pointed out that sustainable investing began in the 1970s, when the first sustainable mutual fund was launched. From then on, additional milestones have paved the way for sustainable investing to become more and more popular, such as the launch of the Dow Jones Sustainability Index in 1999, the development of the UN Principles for Responsible Investing (PRI) in 2006, or the launching of the Global Impact Investing Network (GIIN) in 2009. In more recent history, the appearance

of the COVID-19 pandemic accelerated the adoption of sustainable investing, with a specific focus on social responsibility. This increased interest was also captured by a CFA Institute survey, in which 67% of the participants chose ‘social’ as the ESG area they take into account in their investment analysis or decisions; in 2017, this figure was a much lower 54%. Moreover, the share of respondents that do not consider ESG factors for their investment analysis or decisions decreased from 2017 to 2020 from 27% to 15%, again highlighting the importance of the topic in today’s markets. Furthermore, according to an analysis performed by the International Capital Market Association of the Environmental Finance database, social bond issuance in 2020 was more than USD 11.5bn through mid-May, an 86% increase from the same period the previous year.

The interest in ESG investing was also tangible in the CFA Institute survey that I mentioned, in which 47% of institutional investors stated that they were interested in ESG investing to generate higher risk-adjusted returns, whereas the desire to advocate personal or social values came in lower at 32%. This same trend was apparent in younger investors (i.e., ages 25 to 34), while other age brackets, as well as retail investors, seemed more interested in prioritizing their values when performing an investment.

Before we move on, it would be relevant to outline a couple of points that investors should consider before they enter the ESG investing sphere. First, investors need to define what ESG comprises specifically for them. This can be determined through a suitability questionnaire, or simply by establishing which of the three letters of the acronym – be that the E, the S, or the G – are most relevant to them. This is important to determine which focus they would prefer to have within their investment universe. Moreover, if the investor decides to enter the ESG sphere through an ETF or a fund, they need to perform thorough due diligence on the fund per se and see whether its interests, its mandate, and the companies it is supporting are aligned with the investor’s principles and beliefs. This part should also help investors avoid ‘greenwashing’, a topic we will discuss later today. Furthermore, a fundamental element to identify the interests and principles of both companies and funds relies on their capacity to do ESG reporting, and whether those reports are aligned with industry ESG standards.

On its face, sustainable and ESG investing sound appealing and, according to a KPMG –CAIA–AIMA– CREATE Survey from 2020, is being propelled mainly by institutional investors who believe that the traditional modus operandi of investing, which only considers risk and return, needs to be rewritten to address ESG factors. In his 2020 annual letter to shareholders, BlackRock’s Larry Fink emphasized the effects that climate change could have on the reallocation of capital, and not coincidentally, the term has never been more popular since according to data from Google Trends compiled by the CFA Institute.

Nevertheless, there have been issues around sustainable and ESG investing that make its implementation more challenging – starting with its target users and potential clients. According to the previously mentioned CFA Institute survey, a lack of client demand remains the top reason that firms do not consider ESG issues. Another point that should raise signs of worry across market participants is that, for 33% of investors, there is insufficient knowledge of how to consider ESG issues, as can be seen in the following graph.

Even if one highlights the increase observed in the materiality of ESG issues when investing – considering the decrease of 17 percentage points portrayed by this survey – there is still a long way to go if we want ESG and sustainable investing to be a primary factor for portfolio managers, asset allocators, and clients. This same trend may be gleaned from the afore-mentioned KPMG survey as well, where 31% of the surveyed sample affirmed to be in the “awareness-raising” phase of impact investing implementation, whereas 10% still had no implementation. One possible explanation for this shortfall is the lack of quality and consistent data on ESG factors. This was noted by S&P in a report where they highlighted those two factors as the key challenge in addressing confusion in the ESG space. Additionally, the rating agency highlighted that “the quality and consistency of post-issuance use of proceeds and impact reporting is still highly unstandardized and fragmented across issuer types and regions making it difficult to compare and aggregate performance.”.

Furthermore, another challenge that investors are facing within the reporting realm is the one where they must identify whether the claims from the issuers are trustworthy and reliable, or if those have been ‘greenwashed’. Here we need to take a brief pause and define what the industry means when it uses the term ‘greenwashing’. According to Investopedia, “greenwashing is the process of conveying a false impression or providing misleading information about how a company’s products are more environmentally sound. It is considered an unsubstantiated claim to deceive consumers into believing that a company’s products are environmentally friendly.” The green-washing concern is of high importance for investors: a Quilter Investors survey conducted in May 2021 showed that this specific challenge was the biggest concern for almost 44% of investors, who have become “increasingly sensitive” to the effects of companies that could have potentially exaggerated their green credentials. These concerns were also visible in the previously mentioned CFA Institute report, where 78% of the participants of the survey considered that there is a need for improved standards around ESG products to diminish ‘greenwashing’.

“Investors have revealed elevated concerns that proceeds stemming from sustainability-linked instruments may be funding projects without a clear beneficial impact.”

Meanwhile, additional concerns have started to arise in the ESG industry around “sustainability-washing”. Given the importance that new types of sustainable financing tools – such as social, transition, and sustainability-linked instruments – have started to attract, this has become even more relevant considering- ing that investors have revealed elevated concerns that proceeds stemming from sustainability-linked instruments may be funding projects without a clear beneficial impact. Moreover, an additional concern that comes from the sustainability-linked instruments is that those issuers could be tempted to set performance targets that are not ambitious enough, meaning that the issuer would not have to demonstrate a significant improvement over its business-as-usual strategy, or it would not require a significant investment to achieve those targets.

Another obstacle that ESG investors are facing is the heterogeneity of ESG reporting that the industry currently has available. According to data from KPMG, 57% of surveyed hedge fund managers admitted that they do not currently report on ESG performance at all. Of those who do, 11% use customized metrics, and 23% use PRI. Nonetheless, expectations here are more optimistic than in other ESG facets, given that ESG reporting has gone from ‘nice to have’ to a ‘must have’.

On another note, investors have debated around the possible existence of a ‘greenium’, defined as the difference in yield between a traditional fixed income instrument and one that has ESG objectives, more specifically green bonds. The presence of this ‘greenium’ has been discussed across investors, and its existence is dependent on different factors. First and foremost, ‘greeniums’ should be seen as an issuer-by-issuer case and should not be determined in a general analysis, while also taking into account that not all green bonds have a conventional peer against which they can be compared. Secondly, the expected increase in green bond supply may help ease any signs of premium that green assets could have exhibited, due to being scarcer than its traditional peers. Now, let’s consider a specific case: AES Andes, the Chilean electricity producer, and distributor company tapped the markets in 2019 by issuing a 60-year green bond, the first for the company. Luckily for us, AES Andes also has a traditional bond that matures in 2079, which allows for an initial analysis in terms of ‘greenium’ existence. When comparing the historical yield of the two bonds since the green bond was issued, one can highlight that the average spread between the green and the traditional bond is 11bps, as can be seen in the following graph.

Nonetheless, one can observe that the yield of the green bond was largely superior (almost 200bps more) than its traditional peer only in March 2020, when the company reported a capital increase of USD 500mn to finance its renewable energy investment plan. The market reacted sharply to this announcement, considering that the company was not capable of funding part of its green strategy, which in the end made the green bond perform worse than its traditional peer. As stated before, this is an isolated case and each bond should be evaluated within its own context, but it seems that the market is casting aside the ‘greenium’ that could have been charged to green bonds before.

Yet another challenge that ESG investors have voiced is the need to create an infrastructure with data, professional knowledge and skills, and technology that can support the proper development of the industry. If we go back to the second graph, we can highlight that the three main factors that undermine ESG investing are, unsurprisingly, these same stated missing ones. In terms of upskilling, a couple of alternatives, such as the Certificate in ESG Investing backed by the PRI and launched by the CFA Society United Kingdom, have emerged in the last years, and most of the investment professionals that participated in the surveys I have quoted stated their interest in building up their ESG knowledge while being aware that ESG should be a fundamental pillar in the security selection process, instead of just one element at the end of it.

In addition to the latter, and as a means to combat both ‘greenwashing’ and ‘sustainability-washing’, the industry needs to focus on the quality of information available, thereby allowing investors to compare and have access to different sustainability metrics, while under- standing the most material considerations from a financial and ESG perspective. According to Standard and Poor’s, the increased demand for more detailed and consistent ESG disclosure will drive improvements in the field, while simultaneously adding momentum to the development of ESG-focused regulatory disclosure and reporting frameworks.

— “According to Standard and Poor’s, the increased demand for more detailed and consistent ESG disclosure will drive improvements in the field, while simultaneously adding momentum to the development of ESG-focused regulatory disclosure and reporting frameworks.”

Finally, the industry shift towards heightened interest in ESG and sustainable investing would also benefit from an improvement in leadership. Leaders need to set the tone and lead by example while being aware that institutional investors are the biggest fish in this pond, thus their influence – and their leadership example – is crucial for the success of this shift.

We cannot deny that progress has been made, and that interest in ESG investing has increased dramatically over the years. Nations and companies have issued green bonds, preferable to traditional investment alternatives in some cases. Nevertheless, the need for a more standardized, homogeneous investing sphere, where everyone can compare and draw conclusions from an equitable starting point, is something that the industry is still lacking. This opens the door for fraud and/or negligent behavior from bad actors. But it is in moments like this that we should remember the words of historian, philosopher, and playwright Howard Zinn, “We don’t have to engage in grand, heroic actions to participate in change. Small acts, when multiplied by millions of people, can transform the world.”

Melissa Ochoa Cárdenas – Insigneo’s Investment Strategist

MBA | Masters in Disruptive Innovation (MDI) | Impact Investing | Sustainable Finance
I am a finance professional with five years of experience in fixed income research and macroeconomic affairs, strategy, product development, and capital markets.

Bitcoin and El Salvador – worth the effort?

El Salvador recently made history after being the first country in the world to implement bitcoin as a legal tender; however, the situation doesn’t seem as flattering as initially thought by president Bukele. It is relevant to remember the initial motives that drove Bukele towards the implementation of bitcoin as a legal tender: firstly, El Salvador’s great dependency of remittances, accounting for almost one-quarter of the country’s GDP. Secondly, this project is Bukele’s attempt to bring Salvadoreans closer to financial inclusion, given that most of the population doesn’t have a bank account.

During the implementation day, several inhabitants were unable to download “Chivo”, the e-wallet developed by the government through which Salvadoreans were supposed to be able to perform payments, to the point that it had to be taken down from service after experiencing technical glitches.

Some weeks after the implementation, the road ahead still looks bumpy. On the one hand, the volatility of the cryptocurrency – which sometimes seems to be its trademark – has remained, while the slack implementation of bitcoin has been met with protests that grow by the day: some businesses are refusing to accept bitcoin as a means of payment – even some government offices are not taking the cryptocurrency –, shielding themselves in their lack of technological support to implement it. Furthermore, the means through which the population has access to bitcoin are getting more challenging, given that the bitcoin ATMs installed around the country have either been vandalized by the protestors or do not work properly.

Moreover, the Central American country is incurring additional costs to deploy bitcoin implementation, and the population does not seem too happy about that. According to several statements from those who took to the streets to protest, the resources utilized by the government for this project are coming from taxes. In a highly indebted country like El Salvador, where inequality abounds, both implementation and adoption, especially from those least favored who don’t have access to a stable internet connection, remain challenging. Moreover, it is important to remember that supranational institutions like the IMF and the World Bank opposed President Bukele’s plan to implement bitcoin, even if he considered it a means of bringing investment into El Salvador.

— “This is still a developing story, and there is much on the table in terms of future learnings and developments. The full world will be watching.”

Meanwhile, the main argument against bitcoin implementation stems from those who argue that it may fuel illicit transactions and financial instability. The fact that the IMF did not approve the adoption does not help the country’s cause considering it has open USD 1 billion Article IV discussions with the organization. Similarly, the World Bank also stated that it would not be able to help El Salvador in its bitcoin adoption process, citing environmental and transparency shortcomings.

This is still a developing story, and there is much on the table in terms of future learnings and developments. The full world will be watching – especially those countries whose economies are also dollarized, such as Ecuador and Argentina. If the experiment goes well, it would not be surprising to see other economies adopting the same path, despite the recommendations against it.

Melissa Ochoa Cárdenas – Insigneo’s Investment Strategist

MBA | Masters in Disruptive Innovation (MDI) | Impact Investing | Sustainable Finance
I am a finance professional with five years of experience in fixed income research and macroeconomic affairs, strategy, product development, and capital markets.

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