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The Book 2025 Edition

Instability: Debt, Inflation and AI’s Impact on Investing

 


This information is directed at Professional Clients only and is not intended for public use.

Introduction to The Book 2025 Edition

An abrupt shift in the geopolitical environment and change in the global economic paradigm have accelerated a shift to a new investment regime. We outline a strategic investment response to this challenge; it includes the redesign of pension systems, the role of alpha and the position of tokens in portfolios.

Challenges and Responses for Investors

This years' Book is intended to guide asset owners’ investment thinking over a medium to long-term horizon. This requires not only identifying the looming challenges but also highlighting how investors can and should respond. That’s why we’ve laid out the book in two main sections.

Part I: Challenges
 

  • A growing government debt burden
  • Higher levels of inflation expected ahead
  • The impact and broader implications of AI
  • Climate change and a slower energy transition
  • A major geopolitical shift

Part II: Responses
 

  • Partition and allocate risk effectively to address changing market conditions
  • Consider taking on more risk to achieve positive returns in a lower return environment
  • Increase allocation to real assets for a more balanced investment portfolio
  • Increased role for tokenized and crypto assets in portfolios
  • Redesign strategic asset allocation of pension systems
  • Embrace active investing strategies over passive approaches for better outcomes

Challenges and Themes for the Road Ahead

We set out the key strategic issues investors face directly or indirectly. Notably, structural tailwinds that have driven decades of strong real returns have run their course or are likely to reverse: deglobalization, high public debt levels, demographic change and climate. There’s hope that AI can help offset some of these forces, but we don’t know how much it will help.

Debt Burdens

The government debt burden across G7 economies has returned to its lofty heights at the end of WWII, mainly to keep consumers happy.

The cost of servicing that debt is growing, and letting inflation run hotter might be the easiest political way out of the problem.

EXPLORE TOPIC
Higher Inflation

The future likely holds higher inflation, so investors will need to put more weight on maintaining purchasing power.

This point is highly relevant, given questions about long-term public-debt sustainability and the temptation to use inflation as a relief valve.

EXPLORE TOPIC
Artificial Intelligence

It’s hoped that AI will unleash a wave of productivity to counter lower economic growth. But it also brings big questions, including what the future of democracy holds and the meaning of money. These types of risks don’t tend to show up in return forecasts.

EXPLORE TOPIC
Climate Change

The energy transition seems to be going more slowly than initially hoped. As it stands, it may not meet the current expectations for achieving net-zero emissions by 2050. This creates additional uncertainties for investors.

EXPLORE TOPIC
Geopolitics

Markets struggle to price the risks from geopolitics, adding another layer of uncertainty to investment plans. With geopolitical dynamics shifting, investors must take a broader view of potential future scenarios.

EXPLORE TOPIC

Responses for Investors

The challenges outlined above are daunting, so The Book also lays out actionable strategies investors can deploy to respond. There’s a common thread running through these strategies: the need to adjust asset allocations to reflect a new investment regime that will likely feature lower returns and higher inflation (see chart below).

Scatterplot showing risk vs. return for various asset classes, with labeled dots representing each class.

Historical analysis and current forecasts do not guarantee future results.
The circles represent real returns and volatility from January 2010 to December 2022 for the major return streams investors can buy. The arrows represent the AB Institutional Solutions team’s forecasts for the next five to 10 years. Private equity return data are from the US Private Equity Index from Cambridge Associates, compiled from 1,562 funds, including fully liquidated partnerships, formed between 1986 and 2019. All returns are net of fees, expenses and carried interest. Data are provided at no cost to managers. Private equity volatility is estimated from the MSCI US Small Cap Value Index, with 15% leverage. For private debt, historical and future volatility is expressed as volatility of public US investment-grade credit. The number is between the historical volatility of public US high-yield fixed income and the Pregin Direct Lending return index. Factor future volatility is assumed to be in line with the post- 1950 historical average!
As of October 5, 2023
Source: Cambridge Associates, FactSet, Federal Reserve Bank of St. Louis, Kenneth R. French Data Library, LSEG Data & Analytics, MSCI, Preain,and AB

We think investors’ strategic responses should be drawn from the following choices:
 

  • Overweight to equities, as we believe they are the largest real asset if inflation rates are elevated but not unanchored; an overweight to the US in recognition of better earnings potential

  • Significant exposure to other real assets, including inflation-protected securities, real estate and commodities. Gold and potentially cryptocurrencies may also be part of this allocation.

  • Underweight to traditional bonds, given that they could deliver lower real returns and be less effective at diversifying equity in a higher-inflation world

  • A distinct allocation to investment factors, given their potential to enhance overall portfolio returns and diversification

  • A meaningful allocation to private assets for their illiquidity premium and diversification from access to returns streams unavailable in public markets

  • Higher exposure to active strategies with potential to deliver persistent alpha—portable alpha mechanisms offer a potential solution to a mismatch of beta and alpha sources

Read the Research

 


Webcast Replay: Exploring The Book 2025 Edition

Recorded Tuesday 24 June

Hear Inigo Fraser Jenkins and Alla Harmsworth as they discuss the five challenges identified in the latest edition of The Book, and the responses they are seeing for investors.

LISTEN NOW

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This information is directed at Professional Clients only and is not intended for public use.

© AllianceBernstein L.P.