Hirtle Callaghan Goes Tactical in 2019

As volatility returns to the market, the OCIO says investors shouldn’t run from risk assets.

T. Brad Conger












Markets offered no safe havens as volatility returned in 2018, and investors should be prepared for more of the same this year, says T. Brad Conger, deputy chief investment officer at outsourced CIO Hirtle Callaghan. Instead of getting mired in worry, however, Conger says now is the ideal time for asset owners to evaluate their portfolios and consider allocations that are better positioned for the late cycle.

Hirtle Callaghan revised its risk signals outlook in response to changes in the market toward the end of last year, shifting its US equities weighting to neutral while maintaining a positive view of emerging market equities and alternative asset classes like private credit. These investments are more active in nature but Conger says they’re also likely to perform well even if the market cools.

According to Conger, while the probability of a recession in the US remains low, US companies are likely to come under earnings pressure from slowing growth, which could disappoint investors. Against this backdrop, Conger suggests refining long-only equities strategies so that they are more selective. Hirtle Callaghan works with investment managers to create long-only equities portfolios of best ideas that have a limited number of high-conviction holdings. The approach maintains the simplicity of long-only but with a bit of an edge over simply buying the index or a generalist mutual fund that offers index-like returns. Placing a few educated bets could help to preserve capital in an environment where the broad market may not be moving in a single direction all the time.

Conger is also increasingly upbeat about emerging markets. He says companies in developing economies are exhibiting strong external balances, positive current accounts, and a “valuation gap that is more attractive than it has been in the past.”

For more stories like this, sign up for the CIO Alert newsletter.


Risk Assets Aren’t All Bad

According to Conger, a cultural shift is underway at smaller endowments, foundations, pensions, and family offices that is driving changes in how these organizations manage their portfolios in response to the uptick in volatility. “There’s a growing recognition that the portfolio needs to be more responsive to market events that happen between quarterly meetings,” he explains. That recognition is increasing demand for risk assets. “Allocators understand that because they aren’t time constrained in their investment process, they can hold more illquid investments and realize the higher premiums that come with them,” Conger says.

Hirtle Callaghan is working with allocators to position portfolios so that they are able to take advantage of tactical opportunities that arise out of volatility and add unique exposures.  “We had some clients do well with investments in European distressed debt last year and other parts of the private credit space,” Conger says. “When you’re running a small endowment of say $100 million, a single private credit opportunity can be very meaningful to the portfolio, creating a differentiated source of outperformance. Giant pension funds are going to have a hard time investing in the same way because the opportunities are too small. Those are the kinds of scenarios we’re working through with our clients now that the market is starting to shift.”


Related Stories:

Hirtle Callaghan Hires First CIO

Hirtle Callaghan Creates New Client Engagement Role

Tags: , ,

Passive Investing to Overtake Active in 2021, Says Moody’s

Indexes now make up a bit more than one-third of funds, but will reach 50% in two years, the agency says.

A credit ratings agency is saying passive fund investing will overtake its actively managed cousin in two years.

Moody’s Investor Service said it is seeing more buying of index funds, a lot of it from outflow from active funds.

The reason for the outflows, the agency said, is that a passive strategy is cheaper for investors and creates “less leakage earnings.” The “leakage” comes from management fees, commissions, and trading costs to brokers, and the risk of poor investment decisions made by managers. All of which lands on the investors.

Last year, an estimated $369 billion was pulled from long-term mutual funds, according to research firm the Investment Company Institute.

For more stories like this, sign up for the CIO Alert newsletter.

The 2018 stock market volatility caused assets to crumble, but Moody’s said it theoretically should have “created more opportunities” for active managers to capitalize on downswings. Instead, it narrowed the gap in favor of index funds, which has steadily been widening since 2006.

“Prior to the downturn [in 2008], you were always hearing soundbites from the industry about how ‘you’re going to need active when the market goes down’ or ‘passive is just riding a bull market, and when the downturn comes, you’re going to see passive outflows,’” Steve Tu, Moody’s analyst who helped conduct the research, told CIO. “That narrative did not come to fruition.”

As of 2018, 36.7% of the US market accounts for passive investments. The firm decided 2021 will be the year investors in the US see index funds reaching 50%.

“That [2021] would be the crossover point for where the market share of passive increases to 50%,” Tu told CIO.  

Other than pricing, a shift to passive investing has occurred due to more mergers and acquisitions occurring among funds, as well as an increased demand for more passive exchange-traded fund assets, or ETFs. As products that cater to the ETF industry grow, so does the value for passive shares.



The organization first noticed the growth momentum among index offerings in 2015, according to Brendan Mullin, the firm’s vice president. “To us, this is one of the biggest secular trends in the asset management industry,” he told CIO.

 “The trend of active vs. passive is akin to the spread of the technology,” said Tu. “Others will say it’s based on some other dynamic. We view it as a more efficient technology. If it’s a better technology and more people that know about it, it’s going to spread over time.”

Moody’s also expects passive growth —and the ETF demand that goes with it— to spread further into Europe as regulations have made the strategy more attractive to retail investors. The European Union’s MIFID II rules last year provided more clarity on active fund fees, and also prevented funds from paying commissions to financial advisers. Currently, about 14.5% of the continent’s investors use index funds, but the credit agency said it will expand to 25% by 2025. Interest in the strategy has also been rapidly gaining traction since 2007.

“These changes will likely push retail investors toward cheaper passive funds, including ETFs, just as they become more widely available through investment online platforms,” the firm said. “European fund distribution has historically been dominated by banks that favor their own products, holding back take-up of ETFs relative to the US.”

 

Related Stories:

Will Index Funds Really Take Over the World?

Why Index Fund Creator Jack Bogle Hated ETFs

Moody’s Cautiously Upbeat on Brexit Extension

 

Tags: , , , ,

«