Portfolio construction themes
There were few places to hide during the first half of 2022. But in the wake of the repricing of many public asset classes, we see opportunities to shift “from pain to gain” as we enter the second half. Our portfolio construction themes focus on ways to combat inflation and on areas of the market that have stabilized given the scope of central bank action that has already been priced in — with a particular emphasis on fixed income.
Fixed income looks more interesting than equities.
Asset class “heat map”
We’re pleased to offer our inaugural set of cross-asset class views indicating where we see the best relative opportunities within global financial markets. These are not intended to represent a specific portfolio, but rather to answer the question: “What are our highest-conviction views when it comes to putting new money to work?” These views represent a one-year time horizon and assume a U.S. dollar-based investor seeking long-term growth.
- Liquid credit over equities: Entering bear market territory for stocks conjures the question of whether the drawdown has created true value, or simply a value trap. The S&P 500 Index currently trades at a forward P/E ratio of 15.7x, about 8% below the 10-year average of 17.1x. But this multiple doesn’t reflect any negative earnings revisions that may come in the back half of the year. In light of this, we prefer to access risk-on exposure through public fixed income credit sectors, which we think offer more compelling near-term return prospects per unit of potential downside risk (see Figure 1).
- Cautiously add back duration: We firmly believe that investors who have shortened duration should consider inching their portfolios back to neutral over the next quarter, particularly as recession risk increases. Our assessment is that bond markets have largely priced in the expected trajectory of Fed interest rate increases. And while investors could still feel a sting — notably after factoring in inflation — much of the pain appears to be behind us.
- Real assets remain compelling: Many real assets can help mitigate inflation, and in some cases are still poised to produce positive real returns. From rent escalators found in commercial real estate to CPI-based infrastructure projects to farmland assets bolstered by rising crop and land values, we see a number of ways to participate in elevated inflation levels or provide a cushion against them.
- Public assets paving the way: Broadly speaking, private assets have yet to endure the sentiment-driven valuation adjustments that public markets have suffered this year, which leads to favorable near-term risk/reward profiles in these markets. For example, public REITs (the FTSE NAREIT Index) are in bear market territory. In contrast, directly owned core real estate (the NCREIF-ODCE Index) posted a 1% gain in the first quarter, the last reported. Private markets remain a key tool to deliver attractive risk-adjusted returns through an economic cycle. Moreover, their experience in 2022 highlights one of the many benefits of private market investing: a shield from day-to-day volatility. That said, it’s difficult to ignore the upside opportunity presented by public markets after they experienced such a severe pullback.
Municipal bonds and high yield look particularly attractive.
Our highest-conviction views:
- Municipal bonds: Across the GIC, we came to the consensus that municipal bonds offer value. Fundamentals remain solid, as tax revenues have continued to tick up and the ratio of rating upgrades to downgrades has increased. Our view is that the asset class has been unjustifiably punished this year by outflows, creating opportunities for long-term oriented, tax-exempt investors.
- U.S. high yield: GIC members agree that corporate high yield looks particularly attractive, with nominal yields north of 7% even on BB rated bonds. Importantly, if the U.S. were to enter a mild recession, we believe spread levels are compensating investors for the probability of higher defaults.
- Infrastructure: Inflation has not peaked, and it likely won’t for another few months. And even after it peaks, it will remain elevated. It is not too late to add inflation hedges. But while equities are typically the best weapon to combat inflation over the longer run, for the near term we especially like infrastructure. It offers defensive equity properties that should benefit in a continued high-volatility environment. In addition, it has historically proven resilient during inflationary periods given its cash flow-heavy, regulated nature. Plus, CPI escalators are built into many contracts, and the replacement value of the operating assets will adjust due to higher costs of commodities and services.
Our biggest area of disagreement? Valuing private real estate.
And where we have disagreement:
- Real estate: Our most intense debate was over private real estate. The committee focused primarily on two things: strong fundamentals in the areas that our real estate team like — health care, industrials and multi-family housing — and the likelihood that the repricing in public real estate might be the canary in the coal mine for private real estate.
- Commodities: GIC members have disparate views toward commodities. Some of us see opportunities from an inflation protection perspective, while others are wary of lofty prices. We wound up offering a neutral positioning, but in all honesty this reflects a lack of consensus more than a conviction.
- Emerging markets equities: Yes, you’ll see the heat map reflect a less positive view of EM stocks, but the committee distilled the view as a call on China, an unpredictable key driver of the overall asset class.
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.
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