“Fuj is a highly valuable asset to the team, showcasing exceptional quantitative skills in evaluating risk premia. His experience helps the IPERS investment team effectively manage tradeoffs across different investment strategies. Fuj’s assistance in evaluating portable alpha mandates within a highly data-driven team is commendable. Furthermore, he serves as a player-coach, providing invaluable guidance to the team’s junior members.”
—Sriram Lakshminarayanan, Chief Investment Officer, Iowa Public Employees’ Retirement System
The CIO Editorial Team shared a dozen questions with all our NextGen nominees and asked them each to pick six to answer. Their answers informed our decision to include them as a NextGen. Below are the answers from John Fujiwara.
CIO: How are you dealing with rising interest rates and economic uncertainty?
Fujiwara: The end of ZIRP, combined with stubbornly high inflation and the de-globalization of supply chains, presents the potential for a dramatically different investment environment going forward. To successfully navigate the path forward, investment teams will need to be more collaborative and risk aware.
Cultivate a “risk-aware” environment: Rising interest rates will have a profound effect on both market liquidity and asset valuations. In 2022, we also watched correlations rise substantially at the worst possible times, dramatically increasing portfolio risk. Risk awareness at all levels of the investment process can help avoid “unintended” bets and minimize unwanted downside volatility.
Breakdown department/asset class silos: While team members can still serve as “subject matter experts,” collaboration and sharing of information across teams will be especially important going forward. For example, when interest rates are rising sharply, it will affect all areas of the market from the S&P 500 to private markets. The future path and level of interest rates should be discussed by all members of the investment team, not just those managing fixed-income portfolios.
Develop in-house trading acumen and infrastructure: The “new world” may require quick and aggressive “course corrections.” Therefore, the ability to effectively execute tactical decisions in-house may be a useful capability going forward.
CIO: What asset classes offer the best options for avoiding or mitigating drawdown risk in an institutional portfolio?
Fujiwara: Cash has been long viewed as a “drag” on portfolio returns. But with cash and short-term rates well above 5%, it has become important to consider it as a “tool” for any tactical asset allocation decision. At the current level of short-term interest rates, it is not too far-fetched to imagine a quarter or two in which cash outperforms both stocks and bonds. Additionally, cash offers you “optionality” and flexibility in your investing process. Cash is extremely liquid and can be utilized to take advantage of market volatility by being deploying during periods of stress in both the equity and fixed-income markets.
It is tempting to want to “chat” about the myriad of long volatility or put-spread strategies that are designed to mitigate drawdowns. But as we observed last year, they can be shockingly ineffective. Currently, there are many “explanations” on just why they didn’t work and new “perspectives” on how to better use them. But at least for 2022, cash was a much better risk mitigator and required no more insight than the timing decision required by any strategy designed to address the “left tail.”
CIO: What traditional and/or alternative asset classes do you think are most important for institutional investors, and why?
Fujiwara: For many years (probably close to 40), we have been in a steadily falling interest rate environment. Bond portfolios have become somewhat uninteresting in a good way, as they have provided a stable coupon and some protection during periods of stress in the equity markets; in other words, rarely a negative surprise. Fixed-income concepts such as duration, rolling down the curve, financing/repo and cash management have been greatly overshadowed by equity topics such as multiple expansion and thematic portfolios.
With bonds still accounting for a sizable portion of any strategic asset allocation, it will be important to think about gaining outperformance there in addition to equities. Good fixed-income managers will be able take advantage of the volatility in interest rates, credit spreads and curve differentials to produce absolute return and sizable alpha. I believe that a renewed commitment to understanding the opportunities in the bond market is very warranted.
Similarly, I believe that, going forward, investors should consider an allocation to an “inflation”-themed bucket. This has been considered in the past but rarely implemented. As mentioned earlier, the changing global macro backdrop will keep inflation in the forefront, and investors need to be prepared to address it.
CIO: What asset class or investment troubles you most right now, and why?
Fujiwara: Investments in the real estate market concern me the most right now, particularly the residential market. Historically, higher interest rates have had the effect of slowing down the real estate market by making mortgage loans more expensive, thus slowing demand. However, the recent rise in mortgage rates has led to an unexpected reduction in the supply of homes on the market. The lack of sellers is caused by their inability to find a new home with an affordable mortgage payment. Key to this dilemma is the fact that most current homeowners have very low interest rate mortgages that, in many cases, tie them to their current homes. The inventory of homes is very low, so the few that are for sale are snapped up very quickly and at very high prices.
My concern is that at some point and for some unforeseen reason, a wave of pent-up supply will come to the market, causing a reversal in home values. Securities tied to the residential market will come under pressure, possibly creating a similar situation to the [Global Financial Crisis]. This would severely cripple our banking system and restrict the flow of capital in our economy.
CIO: What should be an investment trend, but isn’t (yet)?
Fujiwara: One should consider the possibility that the U.S. dollar could lose its position as the undisputed reserve currency of the world. The world essentially functions as one global market, with advances in technology and payment systems now providing many possible options for transacting business (including cryptocurrencies). Additionally, geopolitical tensions and the threat of anyone “weaponizing” their currency can also be a motivation for countries to diversify their reserve currency holdings.
U.S. dollar-denominated assets have benefitted tremendously from our reserve currency status. As a country, we have enjoyed lower overall borrowing costs and a higher standard of living. A fall from this position will profoundly influence monetary and fiscal policy, as well as asset prices. Should the forces of “gravity” start to weigh on the U.S. dollar, I suspect it could turn into a multi-year trend which could affect many asset classes, not just foreign exchange markets.
CIO: What new skills do you think allocators need to be leaders in the field in the coming decade?
Fujiwara: As asset allocators, we should prepare for the investing road ahead to be quite different from one we have been on for the last 10 to 15 years. Interest rates pinned at 0 and excessively ample liquidity have “floated all boats,” with market betas consistently rising. The most straightforward of portfolio constructions have been the most successful.
Higher interest rates and the evolving geopolitical landscape, among many other things, have already started to complicate investment decisionmaking. Leaders will need to be nimbler and work side by side with their teams, often “rolling up their sleeves” to help get projects done. They will have to be familiar with the latest methods of collecting and analyzing data and be capable of designing and implementing platforms for research and analysis. As such, they will need to be more familiar with quantitative methodologies and financial engineering concepts. Most certainly, they will have to be open-minded to new ideas and approaches and be willing to challenge entrenched beliefs with thoroughly researched alternatives.
Future leaders in the asset allocation field will need to prepare themselves to be “experts” in risk and risk-taking, as fiscal and monetary policy are less likely to be supportive going forward.
