MASTERCLASS: Multi-Asset Investing In A Volatile Environment

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  • 56 mins 55 secs
Two multi-asset investment experts discuss multi-asset investing and the associated benefits, risks, biases, and strategies being employed in today’s volatile environment.
  • Adrian Helfert, Senior Vice President, Chief Investment Officer, Multi-Asset Portfolios, Westwood
  • Jordan Alexiev, CFA, Portfolio Manager, Fidelity Investments

Channel: MASTERCLASS

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Jonathan Forsgren: Hello, and welcome to this Asset TV Multi-asset Masterclass. We'll be talking about the advantages of multi-asset investing, assessing risk and biases, and strategies being employed in today's volatile environment. Joining us to share their expertise on multi-asset investing our Adrian Helfert, chief investment officer of multi-asset at Westwood Holdings Group and Jordan Alexiev, portfolio manager at Fidelity Investments.

Jonathan Forsgren: Adrian, Jordan, thank you for joining us, Adrian. We'll start with you. Can you describe what multi-asset investing means to you and what are some of its advantages compared to a sleeve approach?

Adrian Helfert: Multi-asset is the ability to take multiple asset classes, as the name on the tin says, which are bonds, equity, commodities, potentially, derivatives, and any other exposure that I can find. Within bonds, that means corporate bonds that may mean securitized bonds, interest rate, sensitive bonds, or government bonds. Combining those in a way that allows me to target, very efficiently, different outcomes. Those different outcomes could be growth orientation, it could be an income orientation, a risk minimization orientation as well. By doing so, in multi-asset, that allows me to go across the capital structure spectrum. It allows me to go across the quality spectrum, across the style spectrum, whereas individual sleeve approaches are barriered. For instance, if you are an investment grade corporate bond fund, then as a bond gets downgraded into high yield land, you're forced to sell, you may miss out on value on that for that reason. Same with an equity fund, you may have a style bias on your equity fund or a risk barrier on your equity fund.

Adrian Helfert: Now, we have the ability to say, "Well, actually we squeeze the balloon and we saw that value came out this direction, we can chase that value where it lies." That's number one. Number two is when I talk about risk minimization, just think of your old school modern portfolio theory. I'm able to then add assets that decorrelate yet provide similar risk characteristics. By decorrelating, it means my risk adjusted returns can be improved by going across that quality spectrum, across that capital spectrum. So it's an ability to actually facilitate, in a very efficient manner, all of those asset classes.

Adrian Helfert: One thing I'll add there is that oftentimes you look and you say, "Well, why shouldn't I just simply have individual sleeves? Why shouldn't I just have fixed income?" A multi-asset approach actually fits very well with those that have the individual sleeves. You might have an individual sleeve in large cap value or an individual high yield fund. Having a multi-asset implementation is different in that you can target a risk controlled paradigm there, your best risk adjusted return. By doing so in an efficient manner that's decorrelated, because we are pairing off assets, pairing off exposures in a way that some sense not dissimilar to a hedge fund yet we are a long orientation. It means we're going to be decorrelated to your individual sleeves. It's going to push out your efficient frontier. Modern portfolio theory is we're going to provide you with a best risk adjusted return, decorrelated, we're going to fit well within the sleeves. Then there is room for that, even within those that have the individual sleeve sleeves.

Jonathan Forsgren: All right. We'll come to you, Jordan. In a multi asset implementation, do you evaluate risk of different asset classes differently or the same across your strategies?

Jordan Alexiev: Yeah. Hi, Jonathan. Thank you for the question. Well, we have clients that run a broad range of investment objectives, from defined benefit plans to public plans, to endowments, to foundations and even individual clients in some of our more tactical portfolios. The objective of each client is different. They all have different assets. They all have different liabilities, level of risk tolerance, the amount of tracking error they can take to achieve their objectives. We also see clients that have different constraints on to which asset classes they can use in their portfolios, how much liquidity they need and what is the overall universe of acceptable investments. That said, we take all these different client considerations and we try to express our high level asset allocation views in a consistent way across all our portfolios. We use a lot of qualitative tools, a lot of technology goals behind this effort to make sure that we have scalability and consistency of our views.

Jonathan Forsgren: All right. Back to you, Adrian. I recently saw your [inaudible 00:04:58] profile. You were talking about removing bias from investing when it's not helpful. Can you describe a little bit about these biases and how you avoid them?

Adrian Helfert: Most certainly. Well, bias within investment management comes in many different formats. It comes within look-back bias or group-think bias, if you will, of following the market and thinking the market is correct. It comes in utility bias of being aversion to risk, when you know of past events. Comes in information bias of over utilizing individual pieces of information. This is new. This is within the last 10 to 20 years, if you consider that new, we've had this massive proliferation of data.

Adrian Helfert: That data is no longer am I waiting for the Q or the K to come in the mail, I'm actually hitting a button it's there within under a quarter of a second. I can do that with thousands of them, which means on one hand, I can have all the data there that tells me what good opportunities might be, that allows me to dig into the data that allows me to immediately go to page 57 and look at the footnote without having to flip through. It also says I can aggregate all of that stuff in a way that says what actual information is helping me make good decisions or what is producing good alpha.

Adrian Helfert: We are able to use all of that at the front end, as opposed to flipping through and waiting for the next opportunity or following a set number of companies, as the old school really was. That was really the old school sell side model of, let's follow thousands of companies, or have an analyst coverage of X. Let's wait for value to percolate up. In some sense that works, you get to know them really well. You know the CEO, the CFO, the CIO. You know when the CFO says something it probably means he's going to change financial policy. At the same time, we're looking for value to occur wherever it may occur and inclusive in the capital structure.

Adrian Helfert: We're able to screen for all this data. We're able to back test it and say, "Well, what's worked in the past? Might that work in the future?" That doesn't mean we are going to automatically invest in it, but we're going to boil the ocean and see where the big fish are floating, because we want a fish there. Removing investor bias is really removing at the front end of saying, "Let's look for opportunities where they might lie using this proliferation of data and find those opportunities." Kick the tires on those opportunities for which we say, "Okay. Let's actually look and talk to the CFO. Is financial policy going to change? Is the revenue path that they're actually projecting, hen I talk to the CEO, is he really confident about VR or bloodborne vaccines or whatever it might be?"

Adrian Helfert: The front end is where you want to employ that reduction in investment bias. You don't want to look at a company and go, "Oh my gosh. I know that CEO and I know his policy," or, "I've seen what happened with this type of company in the past, I don't want to be involved." Let's do some mechanization at the front end, that we can now do very quickly. Let's employ that in a process that says, "That's pointing to something that I didn't expect and most investors probably didn't expect, which is why there's an excess premium available. Let's capture that premium."

Jonathan Forsgren: All right. Now we're going to go to you, Jordan. What is your secular and cyclical outlook for multi-asset investing?

Jordan Alexiev: Yeah. The way that we think about investing, it's not very different from the way that we think about taking on a long journey and trying to get to a certain destination. If you think about, let's say for example, going from Boston to New York, I need to know a few things. First, I need to have a general sense of direction, whether I'm have to be traveling north or south or west or east. To us, that's the secular outlook, which really forces us to think about the overall cash flows of various asset classes. Why do you get compensated to invest in those over time?

Jordan Alexiev: Once you have a map and the general sense of direction, you need a sense of how to get there and that's where you need navigation systems or a map or a compass. That to us is the cyclical outlook. So figuring out how do you get from point A to point B. I'll give you an example. To travel from Boston to New York is about 200 miles, maybe three and a half hours. You can divide the distance by the speed and that will give you the average mile per hour that you need to drive. The problem is that once you get in the car, if you set your car to autopilot with that average speed, you would end up in a major car accident, because things are never average and they're never the same. That's where you need the tactical overlay and trying to understand how things are different this time around and what you need to take into account in order to arrive at your destination safely and hopefully on time.

Jordan Alexiev: With that backdrop, when we start to think about secular views, we tend to spend a lot of time thinking about valuations. Despite the recent correction in a lot of markets, when you think about their outlook for future returns, we tend to think that they'll be much lower than what we've been accustomed to over the past couple of decades, which means that a buy and hold investor, that holds a particular asset mix over time would probably have a slightly tougher time achieving outcomes.

Jordan Alexiev: When we think about cyclical backdrop, we try to understand where different countries in their business cycles. We've been doing that for more than 20 years and have pretty deep understanding of how economists and markets interact. Let's run through the major economies. The US is in, what we call, a late cycle. We tend to think about the business cycle as being driven by four phases; early cycle, when things are really great coming out of a recession. Mid cycle, when you have the bulk of the economic expansion with increasing economic activity, but a slower pace. Late cycle, when that growth starts to moderate, margins start to get challenged. You see much tighter liquidity and you start to see a build up in inventory and subsequent reduction in activity. The US is in late cycle, not at the end of the cycle, but progressing relatively fast over the past couple of years.

Jordan Alexiev: What happened after COVID is that we had this massive shock that forced all global business cycles to synchronize. We had a massive recession and then we had the policy response with the subsequent massive rebound. Since the summer of last year, we've started to see a decoupling of the major business cycles. China has been in a growth recession for almost a year now. They've started to respond to that, slow down with some incremental measures, but the question is, is that enough to resurrect a failing real estate market with a lot of challenges and very high valuations? The two most important economies in the world are slowing down. You have Europe, which, arguably, is already in recession with very high energy prices and food prices and a central bank that is really trying to fight inflation by raising rates. Europe is in a classic stagflation environment, that tends to be challenging for a lot of assets and general economic conditions.

Jordan Alexiev: Then we also look at the fiscal picture and the monetary picture around the world. A couple of years ago, the US fiscal deficit was running at about 15, 20% of GDP. This is probably as big as it was during the second world war. But what has happened, over the past year, is that fiscal deficit has shrunk. In the second quarter of this year, the US government almost ran a fiscal surplus, something that we hadn't seen in almost 20 years. If you think about the way that fiscal deficits propagate through corporate profits and margins, we're likely to see a deceleration or continued deceleration of earnings as the year progresses.

Jordan Alexiev: Back to where we are cyclically. I think that the global economy is slowing down. Typically, when supply and demand run into each other, as they have been over the past couple of quarters who tend to see rising inflation. That's a byproduct of this late cycle environment, which is now being amplified by the secular backdrop of slightly higher inflation and a lot more tendency to experiment with monetary policy. We think that now is the time for investors to think about battening down the hatches, becoming a lot more liquid, a lot more flexible, and planning for opportunities that come along when the dislocations happen.

Jonathan Forsgren: There's a lot of talk about a US recession, potentially, but a few bright spots like employment have held people back from making an official call. What are your thoughts on this?

Adrian Helfert: Funnily enough, unemployment needs to rise. The fed would say the same, is that is the overheated area of the economy. Whatever happens, I think we are going to see unemployment rise. I'll come back and say, I do think that we're going to see a downturn in economic data, almost because it needs to happen to slow the inflation paradigm that we've seen. We cannot see a slowing of inflation really, while five plus percent wage inflation to feeding through. Retailers are simply looking and saying, "I'm going to raise prices because, A, I can, and B I have to, because my margins are getting compressed from my employees." We do see a slowing of economic data. The Fed is engineering that slowing of economic data, of course, they pulled the punch bowl. This is not new news. This is where they've started. We're going to see them continue to do that until they see the whites of the eyes of realized inflation flow through, not expected inflation.

Adrian Helfert: It's surprising when you look at that expected inflation that the 10 year breakeven rate, which is expected inflation, is lower now than where we started the year. For all the rhetoric around heightened inflation metrics, you might actually say the Fed has broken the back of inflation already, in the future, but they're not operating to that. They're saying we're going to wait till realized inflation feeds through, and then maybe we'll be data centric, data dependent.

Adrian Helfert: We're going to hear more about that on this Friday when we have Chairman Powell actually speaking, but for now, we are going to see a slow down in economic data. We're going to see that more in 2023. We have an expectation of sub 2% growth this year. Probably, sub 2% growth again next year with potential second and third quarter significant slowdown. Whether that categorizes as a technical recession in two quarters, we think that it's likely that we're going to see that in the next 24 months, whether the National Bureau Of Economic Research, that secretive body of individuals that meets who knows when calls it, is a little more speculative and depends on other factors than just the two quarter slowdown.

Adrian Helfert: But you're right. There are some bright spots. It's not just unemployment. It is that we have come into this in a different place than in 2008. 2008, we had an over leveraged consumer, we had large scale mortgage equity withdrawals, where you were taking money out of your appreciating house and buying the fancy red car. We have less of that now. We have less of the card debt that has accumulated. We do have some corporate debt that has accumulated that could lead to some retrenchment there, but largely, we don't have what's called the pig and the snake, which is that those near term liabilities, that we get worried about when financial conditions close, then corporations come and go, "Oh my gosh, I can't refinance my liabilities." We're in a better spot from resiliency. What that likely means, as far as a slow down, is it's not going to be as dramatic as we have seen in the past.

Adrian Helfert: It could mean that, as we're seeing, I think over a more recent period now, that the Fed has the capability to not do what many have prognosticated, which is they're going to raise rates up to call it 3.625, midpoint rate on fed funds rate. Then suddenly because of realization of economic data, then drop rates. Up until about a month ago, it was expected that they were going to do just that, that they were going to raise rates to a terminal rate of around 3.625, mid rate, 3.5, and then they were going to drop rates twice. We don't think that is going to happen. We think it is much more likely that the Fed is going to go, "Tough love."

Adrian Helfert: What we need to realize now is we're going to get to a point of inflation realization that we are not going to do this too early, lest longer term inflation actually rise up above, call it, 2.5%. 2% the barrier and we're hoping to get down to just somewhere between 2.5 and 2% at this point. That tough love means something else that Jordan said, which is we should expect a little bit lower overall returns that the market has delivered in the long term. Over the last 13 years up until the end of 2021, the average equity return was running around 13 to 16%. There was only one year where it was negative, all driven by the fourth quarter of 2018, when we had the Fed hiking rates or prospectively hiking rates, even further than the market had anticipated.

Adrian Helfert: We would test investors to say, it's probably not only a little bit less, but because of the absence of the fed, providing that put of the tough love policy over the old, molly-coddling policy, because of less absence or more absence of the treasury, providing more financing as he was talking as well about deficit spending. We might see more volatility as well, which reduces sharp ratios for investors. You have lower potential returns for the next several years, with potential heightened risk premium or volatility. It means that you need to find multi-asset possibilities of course, for your investment. It makes, all of a sudden, a 3% US treasury not look so bad.

Jonathan Forsgren: I'd like to compare, Jordan, your view on the potential recession. Are we in one? What is your outlook?

Jordan Alexiev: As we know, the NBR dates recessions with a two year lag. We just have to wait two years to know where we are. Our job as investors is to really invest based on probabilities versus what is being discounted by the market. I'll quickly address the employment question first because, to me, employment is a lagging indicator and it's usually one of the things that turns last in the cycle. By the time that we're very sure and confident that employment is fulfilling the Fed's objectives, probably we'll be already in a recession. We tend to focus more on leading economic variables, such as profits, landing standards, overall credit conditions, and changes in inventories to figure out where the economy is.

Jordan Alexiev: We don't think that the economy is right now in a recession, but it could be in a few months time, because this cycle is progressing much faster than what we've seen historically. A business cycle tends to last anywhere between five and 10 years. Over the past couple of years, we've circled through a complete business cycle in just two years, on the back of the massive policy response and the subsequent reduction of that response. Conditions are tightening.

Jordan Alexiev: Then the question is; what is priced in by the markets? We do a lot of work trying to compare our views about how the world would evolve, versus what is being discounted in various markets. As of June this year, the market was screaming, "We are already in the recession." So markets were behaving that way. A month later, the market was saying, "We're already in early cycle," because equities went up almost 10% in most markets. I think that all the way through these few months, we've been in this late cycle environment, where we have a lot of volatility, as Adrian pointed out, a lot more uncertainty and asset price that are trying to discount that. Over the next few months, we'll see a much tighter monetary conditions as QE actually starts to take place, which could challenge some of these view that we have a shallow recession or will not even have a recession, which is kind of the way that the market was behaving a few weeks ago.

Jonathan Forsgren: Staying on you, Jordan, how does inflation impact multi-asset portfolios? What are some tactical considerations you're employing?

Jordan Alexiev: Yeah. I think that if we take a step back and try to figure out what is the inflation. Inflation is a tax. It's a tax on wealth. It's a very indirect tax, but we tend to see it over time. Certainly, it's been front and center for investors over the past year. Initially, inflation feels good. That's what we call the wealth illusion. We print money. We give it to people and they feel wealthier. But as people start to spend their wealth, they realize that there is not enough goods and services to meet that increased demand. Then we enter the second leg of inflation where inflation is bad, because people realize that their real incomes have come down and their purchasing power has eroded. That's what really the central banks are trying to rectify right now through their tight monetary policy.

Jordan Alexiev: Inflation allows that to be diffused. It favors creditors over debtors. Sorry, the other way around. It favors debtors over creditors. It's hard to say that in that environment, nominal bonds would give you a great return, as a long term buy and hold investment. That's something that investors should keep in mind if they expect a higher inflation environment. Inflation linked bonds might provide a lot more resilience and a lot more diversification to equities in that environment. We've also studied a lot of other environments that have had higher inflation. You tend to see real assets outperform nominal ones, such as bonds. You tend to see equities outperform nominal bonds as well, just because they're able to pass through inflation in a better way, since their business models allow for changes in pricing.

Jordan Alexiev: I would also say that inflation is a lagging indicator the same way as employment is. In order to manage inflation over time, which is part of the Fed's objective function, in a way, they have to act ahead of time to eliminate the extreme outcomes. What has happened over the past couple of years, is the objective function of the central bank has changed. From forecasting and acting ahead of time, the central bank has decided to really wait for the whites of inflation as they did a few months ago and really wait now to see inflation come down in order to change their monetary policy. The problem is that monetary policy works with a lag. We are yet to see the extent to which the tightening that has happened over the past few quarters, we'll start to feed through economic activity. That's something that, right now, the central banks don't have the luxury to wait and see whether they've done enough.

Jordan Alexiev: There is a risk that they've already overdone that tightening. That has implications for investors. Cyclically, inflation probably has peaked, as we already saw with the latest print of numbers. As Adrian mentioned, breakevens have come down. Since the end of the first quarter, they've been trending down. A lot of the gains in commodities that happened after Russia's invasion in Ukraine has been unwound and commodities feed into inflation, they're part of inflation, as we know. It's really a question of trying to square out these long term inflation forces, which we think are here to stay, or at least inflation volatility would be a secular theme to reckon with, with a cyclical slowdown, which would act in the opposite direction. The question is how do they offset each other?

Jonathan Forsgren: All right, Adrian. My last question to you was about the us so we're going to open it up a little bit. how does a global perspective fit into your strategies?

Adrian Helfert: Sure. Well, simplistically, as much as sometimes the world would like to be less geopolitically centric or more isolated, we are a global economy. That means that the covered or uncovered interest rate parity that moves FX movements significantly or via trade lines or via the supply chain impact that we're seeing right now or trade policy, we're going to see those impacts, thus, it behooves investors to understand what is happening in a global macro environment. Jordan mentioned a fair amount about China, about what's happening in China. Of course, China is very significant in the outlook for commodity purchasing and other areas. Thus, we have an outlook for China itself. What's happening in the commodity space, especially in the oil space. Big picture of the S&P 500 is around 30% of its revenues from abroad. As investors, whether we are in the domestic space or the global space, we need to know what the global macro scenario is, and either embrace a certain risk for where we feel like we have insight, or insulate ourselves from that risk.That's actually understanding the space.

Adrian Helfert: Once again, we talk about global asset and global multi-asset is being able to operate across the quality spectrum or the capital spectrum or the style spectrum, but it's also the country spectrum. You might think as well, that when you squeeze the bubble and value comes out. Of course, the European area is about to go through a pretty significant recession. That's going to be driven by oil price inflation, et cetera. I should say energy price inflation on that stand front. That for them means, well, are there better opportunities here than there? Are there better opportunities there? At some point there will be. Assets that become very depressed or the proverbial babies thrown out with the bathwater. Allowing us to look across into international bonds, emerging markets ...

Adrian Helfert: Emerging markets are an interesting area now because they've already corrected for much of the pain, we feel like, on some of the economic downturn. It may not be time just yet, but there are opportunities there for which we can find. Within even that space, there's quite a bit of diversification between looking at Brazil and looking at China or Korea. Being able to look across that entire space is similar to the investment paradigm of saying, "We're multi-asset." We want to be able to chase value wherever value occurs, add alpha for investors, where there is obvious value in relativity to other sensitive assets that we have.

Adrian Helfert: At the same time, we're macro investors and there is no true top-down or no true bottom-up, in my sense. We're bottom up investors, meaning we invest in individual assets, but if I fail to understand the dynamics of what's happening in China or commodity purchasing or supply chain impacts from whether, oh gosh, China and Taiwan have a flare up in activity or something, then it's going to negatively impact the portfolio, because that's going to be a material macro influence, whether or not revenues change on the individual company that I invest in.

Jonathan Forsgren: Keeping it on a kind of global perspective, I'm going to go to Jordan with a question here. How are geopolitics and rising populism impacting your strategy?

Jordan Alexiev: Thinking about geopolitics, maybe about 10 years ago, our research teams started to entertain the idea that we've reached the peak of globalization. That was pre the multiple elections that we had over the past five, six years that brought in a lot of leaders that have a populous bias towards the way that they govern their countries. What we learn from textbooks is that globalization allows for faster growth, it allows for a bigger pie, overall, but it doesn't guarantee that the gains of that growth expansion are proportional to the way that people invest in those. That's why we've seen this rising populism around the world and for more domestically oriented policies.

Jordan Alexiev: What this means is that rising populism would probably tend to feed into higher costs for inputs, a lot more inflation, and probably a shift from capital towards labor, as labor is able to command higher wages, which in a way, would translate into lower margins for a lot of corporates that were used to run capital-light businesses and be able to have their suppliers invest on their behalf.

Jordan Alexiev: We've seen also very, a lot of rising tensions in the world. We have the major super power, the US, now being challenged by a rising power, China, and an old power, Russia. Whenever you have more than two great powers trying to compete, you have a much more unstable equilibrium as we've seen over the past few months, which means that there is probably going to be more uncertainties that are hard to plan in advance.

five or six years ago, when there was the [inaudible 00:33:04] revolution in the US, and there was abundance of oil, we not only benefited from low volatility of inflation and low geopolitical volatility, because we had plenty of the major commodity in the world, but that also translated into lower volatility for financial assets. We had this pretty benign environment over the past five, six years leading up to the COVID crisis, where we were used to much lower volatility than historically realized. That's likely to change, it has already probably started to change.

Jordan Alexiev: One thing that's kind of important to think about is that for the past decade or so, central banks were trying to create inflation by lowering interest rates. We never had a chance to create inflation up until maybe last year, over the last couple of years, because that cheap capital allowed a lot of companies to go out and produce uneconomically. We had a lot of supply versus the amount of demand. What could happen with a rising inflation or rising inflation volatility is that you continue to see lower and lower incentives for businesses to invest. As your discount rate goes up, the ability of a corporate to do more CapEx comes down. We could see a vicious cycle of higher discount rates reducing global CapEx and leading to even more inflation and more instability. Again, that's not guaranteed, but something worth thinking about as we progress with these rather extraordinary times.

Jordan Alexiev: Finally, as we think about investing, we always primarily worry about the return on our capital, the ROI. Well, since the last six months, we also have to worry about the return of our capital, whether or not we'll be able to get our money back, whether or not markets can go to zero, as we saw in Russia. Investing and keeping in mind that some of your money might not be available, is worth thinking about and planning for ahead of time. There's no way to prepare for all these uncertainties. As investors, we have to use probabilities, but thinking about the possible outcomes and having a game plan for different contingencies is something quite important, even more important these days.

Jonathan Forsgren: How do long-term investment themes express themselves in your strategies?

Adrian Helfert: When you think about the vectors of return in an investment strategy, you think about, especially, your bottom-up strategies of idiosyncratic selecting the right companies, the right securities and earning from those. But there's also sector rotation, finding the right sectors that are going to appreciate based on, for instance, the recently misnamed Inflation Reduction Act where clean energy might be a beneficiary or drug prices might impact the pharmaceutical industry. Sector rotation is your second. Then, of course, there is asset rotation or risk-on risk-off. So, do I hold, especially in a multi-asset strategy, more beta or less beta, less sensitivity to interest rates or more sensitivity to interest rates. You've got three there, but you also have things that are, say, style bias of what kind of style bias do I want, that may be interest rate sensitive so a macro variable, but it has other implications as well.

Adrian Helfert: Then, lastly is when we're talking about an investment strategy has having multiple time horizons in it, one is having thematics. Thematics are things like mRNA, I think Moderna and other stocks that produce RNA kind of vaccines. Is that something that is a thematic that we want to be involved in? Is that an emerging area, especially after COVID, we're thinking about that now, or bloodborne vaccines or cloud-based technology where we have a proliferation of data that I've talked about. That's cloud-based technology and machine learning and artificial intelligence. Finding thematics that produce all of those. There're all the ones that we already know about; there's cannabis, which is in the form of legalization in many areas, many people embrace. Electric vehicles is one.

Adrian Helfert: Employing that in an investment strategy means yes, on one hand, Jordan talked about this, a bit of having a reasonably consistent overarching viewpoint that you want to employ and then investing in assets for those that reasonably consistent overarching investment process says, "Well, we believe that this is the outcome in the future.It may be a 12 to 18 month kind of future. This is how we want to be invested for that." But at the same time, there are these emerging thematics that may move slower or faster. The hydrogen economy is a very good example of one of those, that is far off in the future, but the market is going to realize it sooner in the future. When I pick a servicer, one of those that buys one of those energy companies that provides equipment for traditional energy or even alternative energy, I want to pick a servicer that has exposure, not to just blow-out preventers for sub sea drilling, but also hydrogen economy facilitation and equipment for that.

Adrian Helfert: When I think about thematics, I think about choosing those companies that represent where I think the future is, as well as where we currently are, and producing revenues on the back of that.

Jonathan Forsgren: I'm going to put the same question to Jordan. What long-term investment themes do you express in your strategies?

Jordan Alexiev: Yeah. I think that one major theme that is likely to stay with us, for the foreseeable future, is the prospect of higher inflation and higher inflation volatility, which has pretty profound implications for asset allocation. For one, it really removes one of the last three [inaudible 00:39:28] out there, which people call diversification. As we've seen here, to date, stocks and bonds have been positively correlated in an environment of rising rates. That opportunity to hedge equity risk with nominal bonds and nominal treasuries would likely to be a little bit more challenged on a secular basis.

Jordan Alexiev: The other theme that's in a way fitting into that inflation team is the de-globalization perspective that we have. Would certainly shift the way that things are produced, certainly shift the power of labor versus capital. A lot of the beneficiaries in the last decade might end up being in a different position. We think that, under that environment, you're much more likely to favor outcomes and opportunities that provide cash flows over a shorter period of time, as opposed to far out into the future, because if most of your terminal of your wealth is defined by a large terminal value and not much cash flows along the way, you're a lot more exposed to changes in the discount rate.

Jordan Alexiev: When we think about these long-term themes, higher exposure to inflation protection could be one of those. Higher active risk budgets, as I mentioned, an environment where the major betas are likely to be challenged and likely to give you lower expected returns. You would have to generate returns through active management. To me, that's something that people should really think about. Also, in a world of higher geopolitical risk, a lot of things that have never happened could happen and markets can dislocate, especially in an environment where there isn't enough liquidity and market making. Having some kind of a vehicle that allows you to invest in these distressed opportunities and pre-funding that ahead of time is something that is worth thinking about, because opportunities emerge and you have to act on them and you have to have the right setup for those opportunities.

Jordan Alexiev: Finally, there are always beneficiaries when things change. We spend a lot of time thinking about who will be the beneficiaries of this wealth redistribution, either through inflation or different tax structure or different government involvement. There will be losers and there will be winners and it's worth thinking about what those might be and positioning the portfolios accordingly.

Jonathan Forsgren: You both have hit on how we are in unprecedented times, we're not going to see an environment that we've seen over the last few decades. What are clients coming to you more with, in terms of strategy? Have they pivoted direction in terms of strategy that they want to pursue? And then, have you started to favor an asset class over another in the current and future environments? Jordan, we'll start with you. Then, Adrian, we'll come to get your response.

Jordan Alexiev: Yeah. I mean, we've certainly seen people talk more and more about inflation. I think that's been a common theme. Actually, we got interested in investing in inflation hedges a couple of years ago, when inflation was one and a half percent and no one was talking about inflation. Really, the opportunities are defined by the price that you pay to express a view. That has been priced by the markets right now. We feel that now the risk is more symmetrical and could turn against inflation if there's a more pronounced global slowdown. We've seen also a lot more interesting active management. A lot of our clients have allowed us to expand the risk budgets in our portfolios, have allowed us to incorporate other instruments that were not part of their ISDAs ahead of time. There is a lot more flexibility, because people realize that when the environment changes, you need to set a different set of tools in order to be able to navigate that.

Jordan Alexiev: We've seen a lot more interest in more tactical, more dynamic types of mandates, where it's almost like a go anywhere type of structure, where we have the flexibility to really express our asset allocation views with very precise instruments, which allow us to take risks that we think are properly compensated and eliminate the ones where we feel less certain about.

Adrian Helfert: Great. Somewhat in line with that as well of one big thing that we have seen is clients that are interested in alternative orientations and income. What that means is income that is less assuaged or negatively impacted by the deleterious effects of interest rates rising, which comes with inflation. One thing we do is we have something that is a convertible arbitrage or orientation. Others do other things that are different, that try to extract a consistent premium from the market in different areas that is not related to interest rate duration or interest rate sensitivity. That's something that's been, I'd say first and foremost, a big common theme of investors of, I like income. I don't want to wake up and open my statement and find that my bond fund is suddenly down 13, 12, 10%, because that's not what it's supposed to do, but in inflationary world, that's what we're finding. That's number one.

Adrian Helfert: We also see that clients are suddenly more interested in thinking about their equity allocation as style centric. I'm invested in growth, or I'm invested in value. That's always been a paradigm, or we've had that for a long time, but I'm seeing the den of excitement pick up around, actually I want this paradigm a little more, because I see the potential for rising Fed funds rates to negatively impact those cash flows, just as Jordan was talking about. Or on the other side of this spectrum, of course, things like long-term thematics that say, actually I want some long term cash flows, because if we see a growth downturn, then it's likely that, funnily enough, growthy assets as categorized are going to outperform. Some clients say, "I just want to put those aside and think that I'm going to realize some of these changing technologies." We see more interest in that kind of stuff.

Adrian Helfert: The energy space I'll mention as a last one as well of the energy space has been a downtrodden area for which we know the last several years have been a really difficult period for energy assets. I mean, at one point we actually saw futures that went negative, where many of us were out searching, if we had a swimming pool, could we just take it and put it on a swimming pool. In the oil space, that paradigm has changed. Now we see longer term elevated energy prices for many reasons, inflation is one, potential longer term growth. Longer term growth is another one we've seen that these companies have under invested for the past several years, which means we're going to see a dearth of supply. The Middle Easterners have already told us that actually there's not as much excess capacity.

Adrian Helfert: Longer term, we see the potential for energy prices to remain elevated. Guess what? These companies are cash flow generative at prices that are not 80 bucks, not $90, not $70, but below that, given the way their capital structure is set up. We're seeing more interest in that, especially because these are income producing asset classes. It does get back to, especially on the income side, clients are looking for income in ways that they're not going to open those statement and find that because the 10 year treasury went up to from 3% to 4%, their bond fund was suddenly down 9%. They want other alternative sources of that income that is consistent. We're trying to provide that.

Jonathan Forsgren: We're going to go to you, Jordan. What could surprise investors over the coming quarters? And what advice are you giving investors right now?

Jordan Alexiev: Yeah. I think that one thing to think about, as we all are worried about inflation, and I know that inflation is an issue when my spouse asks me about inflation and quotes the current number, which I always find impressive by someone that's not working in finance. I think that one thing that can surprise investors is that we could have actually about a deflation. I know that, that could sound crazy when inflation is closer to double digit numbers in the US and in some other major economies, but when we think about investing, we also have to think about what is currently being priced in. Right now, the premiums for deflation protection are probably in the bottom decile of their history and the premiums for inflation protection in the top decile. They have come off from the highs and the very extremes, but they're the exact opposite of where they were in March of 2020 when everyone was worried about a great depression and no one ever thought that oil would trade about $50 a barrel.

Jordan Alexiev: The starting price really defines whether an investment would be great, good, or just average or bad. Right now, there is quite a disbelief that nominal bonds would ever serve a purpose in an investment portfolio. When you look at historical episodes and sentiment, versus those episodes, where in these extremes where no one really wanted to touch anything that has to do with deflation protection. That was about the time that you really had to start building up a position. That could be one thing that surprises investors over the next few quarters.

Jordan Alexiev: Another thing along these same lines is that we've certainly had a pretty strong housing market over the past few years, but with the changes in interest rates, here to date, a person can probably buy a third less of a house than they could in January 1st this year. When you think about the appreciation of house prices, over the past couple of years, affordability has gone down by almost 80%, which is a staggering number. A lot of people that live hand to mouth and really try to figure out their ability to acquire a house, that has gone down dramatically. That could have a meaningful impact on overall activity, because housing has a big multiplier effect for the overall economy.

Jordan Alexiev: I think that another thing that's also up for debate and could be surprising in the next few quarters, is the extent to which earnings might decelerate in the US. When we think about corporate profits, they're a function of someone else's spending. Either the government has to spend, which is the fiscal deficit or households have to spend, which is de-saving, or you have to spend on the corporate CapEx side in order to generate profits for someone else. As we talked about earlier, fiscal deficits are now a headwind for the US economy this year. A lot of people are affected by falling asset prices and their inclination to spend might be challenged. That could challenge earnings as the year progresses. We've already had a pretty massive rise in oil prices and rates and in the dollar. Historically, this have been environments where you tend to see a much faster, slow down in activity.

Jordan Alexiev: We tend to see opportunities in some of these deflation hedges. When you look at credit, the past few weeks, there was a rally in credit spreads. When we think about where they're priced versus where we are in the cycle, I would say that spreads of 450 to 500 basis points is something that we tend to see mid cycles, when things are good. It's something that is very unusual for slowing growth environment. Some of these growth deceleration might not be fully priced into the corporate markets. We feel that some of our more tactical portfolios can benefit from the ability to hedge this pretty massive common factor, which is the rising discount rate by being able to offset some of the positions with views in the credit space.

Jonathan Forsgren: All right, I'm going to come to you, Adrian, with part of the same question. What advice are you giving clients right now?

Adrian Helfert: Well, number one, I'll come back and just say what's been surprising or what could be surprising. I think Jordan hit it head on with the deflation. We actually see it in a couple of areas. You see it in watches, you see it in boats, you see it a little bit in used cars, you're seeing luxury goods areas. Now, that's not descriptive of the overall atmosphere, but let's think just economically what would happen if we saw a deflationary paradigm. That would be bad. That would be bad. Inflation, let's think about how that impacts us. Well, it decreases my spending capacity, my spending power. That's concerning when we have a high savings that are potentially getting deteriorating and spending power, but it also decreases the value of my debt. My house price goes up 20%. My debt price doesn't go up. I can pay down a little bit more or I'm a little less leveraged by just my overall house price.

Adrian Helfert: If we have higher unemployment and we have deteriorating economic conditions and effectively your debt price is looking higher than your income, that's concerning. Then we see a debt massacre. That's when those occur when we see a deflationary environment overall. That's not expected, but it's something that, I think as Jordan would agree, it's a risk factor and something we watch for. Overall, there are other things that are potentially unexpected right now. One is a growth shock. If we were to see some other avenue of growth significantly that led us to have much higher growth next year, at the same time that the Fed is able to create a higher neutral rate, that'd be very positive. We're not expecting that right now. We are expecting the consensus of a low growth paradigm for some time now, possibly engineered by the Fed, et cetera. That's something that we're mindful of in looking for those somatics. We want to be involved in the event that that does actually happen.

Adrian Helfert: Now, what are we advising investors for right now? We are telling investors that fixed income, in certain areas, is more attractive than it has been in the past. If Jordan and I are right, that the overarching returns of the next several years are going to be lower than expected or lower than, I should say, the long term, suddenly a 3% treasury doesn't look so bad. That's on the tenure. We have to be mindful of inflation because it has deleterious effects on bonds themselves. But as a 10 year treasury at 3%, versus lower perspective outcomes on your S&P 500, that used to be 12%, maybe is now 8%, annualized. That's almost half your returns if that's there. A little bit more income is a good thing where you get the carry in the roll down, the potential for correlations coming back, meaning the potential for the three year side of the 10 year to protect you at 3%, if we see a dramatic growth downturn and it trades down to 2%, meaning you see prices rise is a potential.

Adrian Helfert: There's a little bit more positivity in fixed income, of course, than when yields were very skinny. Maybe you employ that in treasury inflation protected securities, or those ones that give you some inflation protection. We are looking for that inflation protection, similar to Jordan as well, and advising clients to think similarly. We need to think about certain areas. There are some growth prospects, have those thematics in your portfolio, number one. Number two, think about the possibility that inflation will be elongated. That's more a risk than the deflationary possibility I just outlined. Thus, think about the asset mix that you have employed for that, it may be energy prices, it may be housing prices and it may be as well some treasury inflation protected securities.

Jonathan Forsgren: Well, Adrian, Jordan, thank you so much for joining us today and sharing your expertise. To our viewers, thank you for watching. For Asset TV, I'm Jonathan Forsgren. We'll see you next time.

 

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