“Jose has accumulated a significant amount of experience in the markets and has—in a very short period of time—adroitly applied it to allocating assets within our DB plans. Every day, J.P. helps us gain a tactical advantage relative to our benchmarks. The complexities of turbulent markets can be daunting, but J.P. distills the noise into a set of practical actions to help us monetize opportunities the market gives us. We’re very lucky to have J.P. on our team and are excited to support him and see what upside he can help us create for asset returns!”
—Robert Sparling, CFA, CIO, Dow Chemical Company Inc.
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 Jose Hipolito.
CIO: How are you dealing with rising interest rates and economic uncertainty?
Hipolito: In my view, interest rates have gone up, structurally, because of deglobalization and loose fiscal policy around the world. Together, these two factors have brought the level of the neutral rate up significantly, forcing monetary authorities to hike their overnight policy to keep inflation in check. The consequence of such an environment on investments is that opportunity cost is now higher, which makes it harder for growth ventures to look appealing and effectively thrive. This is especially true if you consider that not only are risk-free rates elevated, but economic and geopolitical uncertainties are as well. The way I have been dealing with this scenario on the equity front is by allocating capital where there is value (e.g., defensive companies with steady cash flow generation). On the fixed-income front, I have been putting capital to work in the short end of the curve, where one can get paid very high rates with little to no duration risk. My playbook hasn’t been particularly successful this year, especially in equities, where the growth-to-value trade has given away all gains it yielded in 2022. However, I still think it is the right approach to allocate capital, given the cards we have been dealt. I believe the basic concept of time money value (cash flows now are better than cash flows later) will play a crucial factor in returns throughout the rest of this decade.
CIO: What is the best way to bring more diversity to the financial industry?
Hipolito: We need to give people the same amount of exposure and opportunity, regardless of where they were born, where they went to college, what their political, religious or sexual orientation is. The best way of enhancing diversity is to break silos, encourage everyone to take a shot and to create a culture where everyone has the ability to bring their ideas to the table. At the end of the day, it is the best idea that wins, regardless of where it came from, and diverse ideas cannot be brought forth if there is no diversity of thought. I think many organizations these days are more focused in getting diverse employees through the door by implementing specific recruiting practices, but there is not a big enough effort to engage these diverse employees once they’re in the room. This makes the concept of diverse recruiting less effective. Diverse recruiting does not work if the workplace does not also provide an inclusive culture. For this reason, bringing diversity to the industry or to a workplace is not enough. I like to use this analogy: Recruiting diverse candidates is like inviting them to the party. Giving them a seat at the table and inviting them to dance is what inclusion is about. The two should go hand-in-hand.
CIO: What asset classes offer the best options for avoiding or mitigating drawdown risk in an institutional portfolio?
Hipolito: For the first time in more than a decade, I think cash should be treated as an extremely competitive asset class. It is going to be offering compelling real rates yield with zero duration or drawdown risk as central banks execute the “higher for longer” monetary policy glidepath to curb inflation after many years of loose fiscal policy and deglobalization. It is fairly common for young money managers, like myself, to try and minimize cash in their portfolios, because central banks ran extremely loose monetary policy since 2008. This has created the perception that cash is a consistent drag to returns. It is important to recognize this has now changed, as we have entered a new monetary policy regime that calls for embracing cash as a good alternative to risk assets with stretched valuations. As of now, the estimated earnings yield for the S&P 500 in 2024 is around 4.9%, while Fed funds are expected to reach 5.5% by the end of 2023. It is the first time since I began trading in 2007 that the U.S. risk-free rate is higher than the S&P earnings yield. I also think bonds are very cheap when compared to equities, and, considering the risk/reward ratio, cash should be viewed as a good and simple option for those trying to mitigate drawdown risk without giving up yield.
CIO: What asset class or investment troubles you most right now, and why?
Hipolito: Developed Market Equities is, in my opinion, the asset class that offers the worst risk/reward ratio right now. That is because of how high current valuations are and how much of a tailwind earnings will likely face, given the DM companies have very high negative operating leverage and the fact that we are in an environment where both inflation and policy rates will remain elevated for quite a bit of time. If you analyze the Russell 2000 Index, you will notice that a lot of the companies in the index do not have a balance sheet that can withstand rates north of 5%. I do not see the benefit in holding equities at this level of implied earnings growth with so many outstanding risks out there and when a two-year government bond is offering 5% return. Another factor is the potential cracks from the commercial real estate and consumer credit sectors, which will likely have a heavy impact on broad equity indices, since the financial sector is a big part of those.
CIO: What should be an investment trend, but isn’t (yet)?
Hipolito: Emerging Market (EM) Equities will become a trend very soon. Compared to DM equities, EM equities offer cheaper valuations, less leverage and better yields. It is also worth mentioning that most EM countries are much more stable now than they were 10 to 20 years ago from a political governance perspective. Investing in EM equities is also a currency hedge for the dollar weakness we will likely witness over the course of this decade. Most EMs are big on commodities and therefore tend to have a healthy trade balance. I also think the AI/Tech phenomenon we have been observing this year has taken a lot of focus away from EM. However, EM earnings continue to improve, and their valuations continue to look more attractive. For that reason, I believe it is only a matter of time until we see a rotation into EM equities.
CIO: Which asset manager (exclusive of their firm) has most influenced your growth as an institutional asset manager?
Hipolito: Ray Dalio has always influenced me. I think his methodology is unique. He has a very systematic and disciplined execution approach and, when setting investment strategies, his “cause-and-effect” way of thinking goes far beyond traditional financial analysis. His way of predicting how the current geopolitical climate is likely to affect world’s macroeconomics, and therefore price vectors, and his way of using this to determine which regions, countries and sectors are going to perform best is fascinating.
