The plunge in markets hit institutional investors' portfolios in the first half of this year, but that is not keeping chief investment officers on the sidelines.
Angela Miller-May, the chief investment officer of the $50.8 billion Illinois Municipal Retirement Fund, made adjustments to the pension fund portfolio earlier this year. Like other CIOs at the time, she felt stocks were expensive and the Federal Reserve was making it clear that rate hikes to cool the U.S. economy were coming.
In anticipation of a correction, the Oak Brook-based pension fund pared back its exposure to equities and slightly increased exposure to international equities and global infrastructure, Ms. Miller-May said.
Those trades look really good now, as inflation continues to rise at the highest rate in more than 40 years and asset managers are warning about a possible recession.
"I'm a cautiously positive person, but I think we have some challenges, and some opportunities ahead of us," Ms. Miller-May said. "I think the rest of the year will bring a lower growth and lower return environment with moderate volatility, dependent on the resolution of the demand/supply mismatch and more certainty around Federal Reserve policies and recession concerns."
Ms. Miller-May said institutions like hers must remain focused on the long term. But, if they are selective, pension funds, foundations, endowments and other big investors could take advantage of some investment opportunities in the second half of the year.
Marcus Frampton, chief investment officer of the $82.8 billion Alaska Permanent Fund Corp., said the No. 1 issue facing asset owners is the valuation of private portfolios.
"All the allocators that you read about (in fiscal year 2021) had ridiculous years, with very large venture and tech-heavy private portfolios," Mr. Frampton said. "I see a lot of venture-backed portfolio companies with like nine months of cash on hand and a very different fundraising environment, and I see private equity firms that probably overpaid for some leverage buyouts."
Mr. Frampton thinks that stocks are still expensive and he's hoping the Fed's rate hikes will temper inflation soon. "I don't know how this world can face a 5%, 10-year Treasury rate," he said.
Right now, the APFC is about 4% overweight private equity and venture capital and offsetting that by underweighting their public equities by a similar magnitude. "When looking around, most people aren't offsetting that. We're trying to take a cautious view on equities," Mr. Frampton said.
Something that has surprised Mr. Frampton: an opportunity in a local commodity. The price of gold has continued to slide since the spring so his investment staff has been buying significant amounts. The holdings now make up about 1% of the total sovereign wealth fund's assets, he said.
APFC staff have the flexibility to purchase gold in both the fund's cash and absolute return portfolios, and their current holdings in the asset classes are about $600 million and $200 million, respectively, he said.
The $22.5 billion Orange County Employees' Retirement System, Santa Ana, Calif., is looking at corporate earnings and the labor markets to validate the depth and length of the recession, and keeping its eyes open for good investments, CIO Molly Murphy said.
"We are looking to remain close to our benchmark allocations throughout the remainder of the year but we are also using the next couple of months to identify pockets of opportunities and signals to show us when to overweight certain risk assets again," Ms. Murphy said.
For the past three years, OCERS has been preparing its portfolio for the end of the post-global-financial-crisis growth cycle through small investment strategy changes. For example, OCERS is underweight office and retail. In private credit, the pension has shifted assets away from unsecured corporate credit to asset-backed strategies, Ms. Murphy said.
But what the markets giveth they can taketh away. OCERS substantially increased its total equity allocation in April 2020 when COVID-19 began rapidly spreading throughout the U.S. and caused the fastest-ever bear market. "While that was near-to-perfect timing, the 2022 markets have taken about half of that performance back from us," Ms. Murphy said.
Last year, in anticipation of inflation, some institutional investors added commodities and real assets to portfolios and those who didn't are now wondering if it's too late to do the same, said Rui De Figueiredo, co-head and CIO of the solutions and multiasset group at Morgan Stanley Investment Management. Opinions about equities vary, but "everyone is reconsidering" fixed income, he said. Although, the risk of a slowdown for stocks and bonds also has institutions thinking about non-tradtional asset classes, including hedge funds and private equity.
Temasek, the Singapore government-owned investment company which reported a 5.8% portfolio gain to S$403 billion ($297 billion) July 12 for its fiscal year ended March 31, expressed caution about the coming year, even if at a broad level executives suggested the pain should prove bearable.
Asked in a press briefing how Temasek views the global outlook now, Rohit Sipahimalani, the fund's chief investment officer, said with geopolitical tensions aggravating inflationary pressures and raising the risks of recession, the world is in a "fragile state."
"We're in a bear market right now in the U.S. and Europe," with the decline in value for those countries' stocks almost entirely a function of rising rates, said Mr. Sipahimalani. "We still haven't seen an earnings decline being priced in. We think that is inevitable as we go through the year so … we see further downside in the markets from that context," he said.
"Historically, when you've had a bear market like this … you only trough after the Fed has shown that it's stopped tightening and moved toward policy easing and given the Fed's current stance, we don't see that happening quickly," Mr. Sipahimalani said. "So for that reason we think this could be prolonged downturn extending through end of the year, potentially the first half of 2023," he said.
Alternatives consultant Cliffwater LLC is advising clients to "tilt investments on the margins and invest in defensive strategies that will help to protect the portfolio against the impact of inflation," rather than drastically change their asset allocation, said Stephen L. Nesbitt, New York-based CEO.
Cliffwater recommends investment in defensive hedge funds, primarily global macro and systematic trend-following strategies, which at minimum will help to protect the portfolio because of their diversification attributes. The strategies also are likely to produce low single-digit positive returns in current market conditions when returns of other investment strategies are negative, he said.
Direct lending is one of the safest strategies going forward, said Mr. Nesbitt, noting that as rates rise, the strategy will provide a risk premium over U.S. Treasury bonds as well as an expected return of between 6% to 8%.
Daniel Brady, chief investment strategist at PNC Asset Management, a group that manages $167 billion in assets for clients that include institutions, said equity valuations have come down dramatically and, because of volatility that is likely to persist through 2022, actively managed strategies for fixed-income portfolios "really makes sense, as opposed to just being passive."
Private investment opportunities will remain attractive and serve as a hedge throughout this year, he added.
"If you're looking for a private equity allocation, this is a great year to make those allocations … you might want to look toward venture capital. And hedge funds are still an opportunity with volatility expected to remain elevated when looking for a second-half year strategy," Mr. Brady said.
Jim McDonald, chief investment strategist at Northern Trust Corp., said that because of the level of uncertainty about markets, institutional clients might be less likely to make tactical changes to portfolios. However, high-yield bonds are something Mr. McDonald is talking to clients about. "They are going to be an excellent performer," he said. "We think it is a tactical trade, here."
Sweta Vaidya, head of solution design at Insight Investments, a $1 trillion fixed-income manager, said pension fund officials are concerned about the equity risk in their portfolios and are exploring derisking. "We are partnering with consultants and advising clients to increase their hedge ratios and have a plan to continue doing so as rates continue to increase over time," Ms. Vaidya said.
Angeles Investment Advisors LLC, Los Angeles, which manages $8.7 billion for charitable organizations and about a dozen pension funds, is encouraging clients to hold more cash.
The rapid increase in yields, from zero to above 2%, makes this more attractive, and provides dry powder for when markets bottom. Holding cash is not a long-term investment plan, as inflation erodes its value, but it is more attractive than the alternatives at the moment and has optionality value as well," CIO Michael Rosen said.
Robert Steyer, Christine Williamson, Douglas Appell and Arleen Jacobius contributed to this article.
