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Five portfolio construction themes
The world has been moving through the “dark tunnel” more quickly than we expected a few months ago. While that is good news, it also brings risks and makes investment decisions challenging, as yields are rising and valuations look increasingly full across asset classes. So how to build portfolios? Nuveen’s Global Investment Committee offers portfolio construction themes for our clients to consider.
1. Expect reflation, not runaway inflation
A key question we’re hearing from clients is how to position portfolios in light of possible inflation risks. We are not seeing significant signs of higher inflation, but we think it makes sense to take advantage of the “reflation trade,” as global economic growth improves and yields are experiencing upward pressure.
In fixed income markets, valuations have returned to pre-pandemic levels in most sectors, and we think high yield, bank loans, preferred securities and emerging markets corporate bonds should perform well in a reflationary environment. We also see value in longer duration and high yield municipals. For public equity markets, we suggest focusing on areas such as U.S. small caps and emerging markets equities that appear attractive from a relative valuation perspective. Additionally, we see value in public and private industrial real estate and across real assets, areas that can act as a natural hedge should inflation start to rise.
2. It’s still all about income
Yields are creeping higher, but remain extremely low historically. The search for yield isn’t going away, and income generation will remain a challenge for institutional and individual investors around the world. This means investors should consider different areas of the fixed income landscape, dividend-paying equities and alternatives such as real estate, real assets and private credit as tools to build a sustainable income portfolio.
In casting this wider net, however, investors should understand which risks are entailed to generate more income and how these risks work together. Among a number of tools and options, we broadly categorize possible asset classes into buckets of interest rate risk, credit risk and equity risk. Each offers different yield and volatility profiles (Figure 6), and we suggest investors diversify across different income opportunities and risks.
3. Consider more illiquidity risk
In our observation, many (if not most) investors are under-allocated to alternatives in general and illiquid investments in particular. While many institutions have long leveraged the advantages of illiquid assets, we are also seeing a growing interest in private real estate and direct lending among individual investors.
We see compelling opportunities across the alternatives landscape, particularly middle market private debt, which looks attractive on both a valuation and fundamental basis. We also see value in alternative housing sectors, including single family rentals in the United States and build-to-rent housing across Europe. Select farmland and timberland investments also look compelling, as investors increasingly look to benefit from low carbon investments.
Choosing illiquid investments can be especially tricky, as investors must consider such factors as frequency of pricing and how different investments work within an overall portfolio. It is important that investors understand their illiquidity tolerance, ensuring that investment time horizons match their need for capital. But taking on additional liquidity risk in exchange for diversification and return potential is a strategy we think investors should consider.
4. Lean into ESG themes for alpha and risk management
Investors have been increasingly focusing on environmental, social and governance factors in recent years. And for good reason: For us, ESG investing is not about excluding certain types of investments, but rather a tool to help generate returns and manage risks.
During the pandemic, we saw how strong corporate governance, business continuity, human capital and supply chain management were critical to drive performance across asset classes. And we don’t see that changing. We are finding tremendous opportunity in areas such as renewable energy, clean technology, food sustainability and investments that focus on diversity, inclusion and employee well-being across public and private markets.
5. Harness the advantages of active management
This final theme may be the most important. Volatility will likely remain elevated, and in an environment of relatively full valuations and rising interest rates, long-term portfolio returns could be somewhat muted. Across asset classes, all members of our Global Investment Committee and portfolio management teams are finding investment ideas that are highly idiosyncratic and fast-moving.
Selectivity, research, nimbleness and confidence could all matter more in the coming years.
All market and economic data from Bloomberg, FactSet and Morningstar.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
A word on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Socially Responsible Investments are subject to Social Criteria Risk, namely the risk that because social criteria exclude securities of certain issuers for non-financial reasons, investors may forgo some market opportunities available to those that don’t use these criteria. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
Nuveen provides investment advisory services through its investment specialists.