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Artificial intelligence and environmental issues, particularly climate change, are major trends reshaping the future of investing and are seen by many investors as risks to their asset allocations, according to the findings of a new research study by BNY Mellon Investment Management and Create-Research.

The report, “Future 2024: Future-Proofing Your Asset Allocation in the Age of Mega Trends,” examined how AI and climate change were perceived by investors globally, the investment issues and solutions they are giving rise to and the potential impact of the two “supertanker” trends on asset allocation approaches and the asset management industry.

Eighty-nine percent of the institutional investors with combined assets under management of about $12.75 trillion who took part in extensive and structured interviews as part of the study said they regarded the two trends as investment risks, according to BNY and Create-Research. Almost all of those investors (93%) viewed climate change as an investment risk that wasn’t yet priced in by all the key financial markets globally, while more than 85% saw AI as an investment risk that could potentially provoke societal backlash as well as geopolitical tension, the companies said.

But some of the investors surveyed also saw the two issues as opportunities. More than half (57%) of the respondents said they viewed climate change as a risk and an opportunity, while 36% saw it only as a risk and 7% viewed climate change as just an opportunity and not a risk. Investment-specific challenges related to climate change focused on areas that were unknowable, requiring judgmental calls about the future to be made. Those areas included: Slow progress on carbon pricing that’s leaving investors guessing at what point draconian governmental action will become inevitable; dilemmas about the future of stranded assets, with investors weighing whether to mitigate investment risks now or later at potentially higher costs; engagement with carbon emitters being more difficult for investors in fixed income than equities because of fewer opportunities to engage with companies through voting rights or annual general meeting attendance; and questions on whether environmental, social and governance investing is a risk factor now or will be in the future.

All interviewees in the study agreed that although ESG investing might seem simple, it’s not easy, according to the report. “ESG investing needs a long track record before it is fully mainstream,” it said, adding that before that happens “a certain degree of ‘greenwashing’ as a marketing gimmick is inevitable.” That was an issue recently raised to ThinkAdvisor by Cooper Abbott, president and chairman of Carillon Tower Advisers.  He warned that “there could be a little bit of a bandwagon effect” when dealing with ESG that investors should be aware of. For some advisors, it’s probably “just ticking a box” and not thinking through what it means, he said.

Fifty-two percent of the investors surveyed who stated AI was a risk, meanwhile, also regarded it as an opportunity, compared with 33% who saw it as just a risk and 7% who regarded it as an opportunity only, according to the study.

The increased presence of AI was seen as creating four investment-specific challenges: Corporate lifecycles getting shorter as AI creates winners and losers, as shown by the impact of the earliest versions of the iPhone on Nokia in 2007; sectoral boundaries blurring due to AI reconfiguring “entire products, as seen with Tesla, which straddles multiple sectors, causing valuation issues”; the onshoring of manufacturing activities weakening the prospects for emerging economies as 3D printing shifts the geographical centers in global supply chains; and the intangible values of companies being enhanced in ways that are hard to gauge for asset valuation purposes, the companies said.

In response to those challenges, investors are “increasingly mixing active and passive investment strategies, focusing on idiosyncratic risk in portfolios, targeting emerging innovation leaders and blending hard and soft metrics in their analysis,” the firms said.

“The best opportunity is rarely the most obvious one,” according to Matt Oomen, global head of distribution at BNY Mellon Investment Management. “For investors caught up in the day-to-day maelstrom of constant change, choosing the right path can be difficult,” he said in a statement, adding: “Compounding these challenges are large secular trends, such as artificial intelligence and climate change. Already we are witnessing a change in the way markets operate in response to these two supertanker trends. These will be the defining challenge not just for the current generation of asset managers and investors, but for generations to come.”

Overall, the study indicated that new future allocations could favor private markets more than public ones as the search for uncorrelated absolute returns intensifies. That’s because private debt could be used to support startups, while private equity may be relied upon to capitalize on corporate restructuring driven by AI. Investor allocations to private markets stood at 19-31%, but that’s expected to increase, according to the report. Headlong growth in passive funds was seen over the past decade, with ETFs and smart beta representing 20-40% of interviewed investors’ portfolios and being another area expected to grow over the next decade, the firms said.

Other foundational trends reshaping the global asset management industry include the increased personalization of retirement planning, the emergence of millennials and women as growing client segments, flows into retail and wealth channels growing as defined benefit plans advance into a run-off phase, and one-stop-shop financial planning taking off thanks to the proliferation of iPhones and other smartphones and the arrival of next-generation 5G networks, BNY and Create-Research said.

Their report was based on a survey of about 400 research studies that the firms said was “bolstered by in-depth, structured interviews” by Professor Amin Rajan, CEO of Create-Research, with 45 chief investment officers, investment strategists and portfolio managers among pension plans, asset managers and pension consultants in 16 countries: The U.S., Australia, Canada, China, Denmark, Finland, France, Germany, India, Japan, Singapore, South Korea, Sweden, Switzerland, the Netherlands and the U.K.

— Check out Global Institutions Are Slow Adopters of ESG: Study on ThinkAdvisor.