John Rogers
Money managers are largely in agreement that inflation, volatility and further market drops are all likely to be in the cards for investors the rest of the year.
But that doesn't mean there are not investment opportunities to be found. Equity markets could take a further hit, giving investors the opportunity to find some bargains, but bond strategies could be due for a reversal.
Christopher C. Newman, head of Americas division for T. Rowe Price Group, said in an interview that his clients are primarily worried about inflation and rising interest rates, the impact of these dynamics across financial markets, and ultimately assessing whether their existing asset allocation is designed to achieve longer-term objectives.
"We have experienced a meaningful increase in clients engaging us in an advisory-based capacity to help evaluate various sources of diversification," he said. "For the past 40-plus years, diversification typically meant portfolio ballast during periods of weakening domestic or global growth. However, today the scope of diversification has certainly broadened to include inflation risk."
Mr. Newman added that he sees value in meaningful engagement with clients on dynamic fixed income and alternatives, where T. Rowe Price has invested significant resources to be able to design and deliver a range of alpha strategies.
"In this uncertain environment, our guidance for institutional clients has been to stay invested within their risk tolerance, but be globally diversified as the past decade's narrow U.S. market leadership looks less likely to drive future market returns," he added.
Baltimore-based T. Rowe has about $1.4 billion in assets under management.
Fixed-income strategies also look more attractive to Erik L. Knutzen, managing director, co-head of the quantitative and multiasset investment team and multiasset chief investment officer at Neuberger Berman Group.
"Credit markets are closer to pricing for a recession as spreads have widened, while government bond yields have risen with tighter central bank policy," he said in an email. "As such, Neuberger Berman's Asset Allocation Committee now sees more yield to work with in fixed income, but remains cautious in equities, and continues to favor commodities, uncorrelated strategies and cash to mitigate potential volatility and enable opportunistic investments."
Mr. Knutzen also said he anticipates "high uncertainty and volatility" for at least the next nine to 12 months.
"In that environment, uncorrelated and short-term trading strategies remain useful, as does cash — as both a buffer against market volatility and dry powder for opportunistic investments," he added. "The coming months are likely to be difficult, but difficult periods are those in which the foundations of potential long-term returns are built."
Equity investors, however, are going to feel like they're in a recession — whether or not there technically is one — as the valuation adjustment of the first half of 2022 is set to be followed by downward revisions to earnings forecasts in the second half, he said. "We find it difficult to see how equity markets can escape a second, earnings-related sell-off, after the valuation-related sell-off of the past six months."
Within its general underweight view on equities, Neuberger favors lower-beta exposures, with the exception of a more favorable view on energy (for inflation exposure) and a less favorable view on the consumer durables sector (in light of the anticipated consumer-led slowdown).
Neuberger Berman had AUM of $447 billion as of March 31.
Evan Brown, head of macro asset allocation strategy at UBS Asset Management, agreed that global stocks have not yet bottomed.
"The equity risk premium suggests stocks are still relatively expensive vs. bonds," he said in an email. "We believe that isn't sufficient compensation to hold equities in a slowing growth environment where either volume growth or margin pressure is likely to dampen future operating performance."
And despite mounting economic headwinds, 12-month forward earnings expectations have not come under much pressure, he added.
"Typically, the trough in equities does not arrive until the process of revising bottom-up analyst earnings expectations lower has begun," Mr. Brown noted.
His core view is that market pricing of recession risk is likely to increase from here, and so he is more defensively positioned. "Health care is our preferred sector, as it is by far the least expensive defensive segment of the market," he added.
Commodities and commodity-linked equities, particularly energy, are also an "attractive way to embrace cyclicality," he said.
UBS Asset Management has about $1.2 trillion in AUM.
But equities are not out of favor with everyone.
Ariel Investments LLC is "becoming more and more bullish as the market declines," said John W. Rogers Jr., Chicago-based Chairman, co-CEO, CIO and portfolio manager, in an interview.
"People are so fearful. The common drumbeat of sentiment is very negative," he said.
Instead, value-oriented Ariel is finding "many investment opportunities as prices fall and taking advantage of them," Mr. Rogers said.
Many sectors have been hard hit by market conditions and among those Ariel has been scrolling through for bargains is advertising and media relations.
As for the likelihood of a brutal recession, Mr. Rogers said: "This one, if it happens, probably won't be as bad as earlier events. We've been through worse," he said, noting that Ariel successfully weathered tough downturns in 1987, 2008–2009 and during the early stages of the COVID-19 pandemic, and is now dealing with the impacts of the Russia-Ukraine war.
In response to investor questions about how they should approach these challenging times, Mr. Rogers said "we remind them to be patient."
Ariel managed $17.8 billion as of March 31.
Stephen Mullin, head of long duration and LDI strategies at MetLife Investment Management, said by email that while 2022 has been a "tumultuous experience" for fixed-income investors across the maturity and quality spectrums, the sharp move higher in rates and wider in credit spreads also presents opportunity.
"We believe longer-maturity 'Treasury bonds may have neared their tops," he said. "Although we remain duration-neutral, we are considering flat or declining rates as our base case when evaluating rate-sensitive issues."
Erin Browne, managing director and multiasset portfolio manager at Pacific Investment Management Co., which manages more than $2 trillion in assets, sees an opportunity in duration. "For the first time in my career, duration and fixed-income securities are much more attractive than equities," she said in an interview.
MetLife's Mr. Mullin noted that many of his firm's clients are liability-aware and use fixed income as a hedge. "So, while the total return profile has been challenging and the heightened volatility is certainly cause for concern, most are comfortable understanding that liability valuations are also lower," he explained. "For many of our pension plan clients, funded status has remained quite healthy in the first half of the year as the rise in interest rates offset the drawdown in return-seeking assets. As such, many of those clients are considering additional allocations to fixed income, across the curve, to further derisk their plans."
Mr. Mullin said he is advising clients to begin to add some credit risk with a focus on higher quality credit with fundamentals that can withstand an economic downturn. "For those investors that are still leary of interest rate risk, there are some very attractive opportunities in the short-to-intermediate part of the curve to consider," he added.
MetLife Investment Management had $638.5 billion in AUM as of March 31.
Anthony Woodside, a Chicago-based senior strategist for active fixed income at Legal & General Investment Management America, said he expects market volatility to continue into the rest of 2022.
With rising interest rates, Mr. Woodside said many clients are allocating more to fixed income, and LGIM America employees are responding accordingly.
"For institutional clients interested in picking up more yield within their fixed-income allocations, we have been advocating for them to consider incorporating investment-grade private placements within an LDI solution to capture illiquidity premiums while benefiting from enhanced diversification and structural protections," he said.
Anders S. Persson, Charlotte, N.C.-based CIO, head of global fixed income at Nuveen LLC, which had $478 billion in fixed-income assets under management, said in an interview that equities pose more of a downside risk than bonds for the remainder of the year, citing that fixed-income markets have already largely priced in most of the bad news in the economy, including rising interest rates and higher inflation.
Mr. Persson especially likes high-yield where fundamentals are strong and defaults remain moderate.
Putnam Investments is countering inflation within its multiasset and fixed-income strategies through a reduction to underweight positions in equities and in corporate credit, high yield and emerging market debt, said Jason R. Vaillancourt, global macro strategist. Meanwhile, institutional investor questions about portfolio management in the current market environment and search activity are increasing, he said.
Putnam's clients want to allocate assets to U.S. Treasury inflation-protected securities, but Mr. Vaillancourt added that Putnam is advising against the investment because TIPS are fairly illiquid and are not as good for inflation protection as other approaches.
Among strategies Putnam is recommending for portfolio protection are tail-risk-hedging strategies and some parts of the commodities complex, Mr. Vaillancourt said.
Courtney Degen contributed to this story.
