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ResearchDecember 15, 2022

Howard Marks: A ‘Sea Change’ Has Come to Investing

Risk aversion and higher rates are now embedded features, which has big implications, the celebrated investor says.

Howard Marks has made his mark for decades as a deep thinker about markets. Now the co-chair of Oaktree Capital Management sees a “sea change” taking place in the investing environment, with higher interest rates, loftier inflation and less risk-taking as the new trend.

In the latest of his celebrated memos to clients, Marks wrote, “Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets.”

The investing world will be “different from what it was over the last 13 years—and most of the last 40 years,” Marks continued. “It should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.”

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The benchmark interest rate will be in the 2% to 4% range for the next several years—not far from where it is now—compared with the below-2% standard of recent years. To Marks, “The bottom line is that highly stimulative rates are likely not in the cards for the next several years, barring a serious recession from which we need rescuing (and that would have ramifications of its own).”

A much more pessimistic mindset rules today, with investors expecting a recession, risk aversion rising and the Federal Reserve tightening, he observes. Given that the buoyant equities outlook that reigned from the financial crisis all the way through 2021 is gone, the best news Marks sees is that credit investing finally should offer a decent return.

He points out that the “real fed funds rate,” i.e. inflation-adjusted, is negative. The Consumer Price Index is down, but is still high at 7.1%, and the Fed’s new rate benchmark is 4.25% to 4.5%, which translates to a deficit of at least 2.6 percentage points.

In the memo, Marks gave a historical overview of the two previous seas changes he has witnessed during his financial career, which began in 1969, when he started work at what is now Citigroup as a stock analyst.

The first was the introduction of risk management into conventional investment some 50 years ago, the advent of junk bonds, private equity and other such new financial opportunities. The second sea change arrived with a four-decade run of low interest rates, which of course propelled risk-taking.

Now, with the third sea change, he wrote, “Things will be less rosy.” Nonetheless, the beneficiaries of this switch will be lenders and bargain hunters. That sounds like bondholders and value investors. Marks is known as a value stock player who also forays into credit markets.

UK Corporate Pension Funds Stabilize in Bond Meltdown Aftermath

Meanwhile, in the US, corporate pension funding levels declined in November.

By Michael Katz

Funding levels for U.K. corporate pension funds leveled out in November in the wake of the bond market crisis, while U.S. corporate pension funds saw their funded status drop during the month.

The accounting surplus of defined benefit pension plans for the U.K.’s 350 largest listed companies increased to £31 billion at the end of November from £29 billion a month earlier, after surging by £24 billion the previous month, according to Mercer’s Pensions Risk Survey data analysis for November.

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The value of the pension plans’ liabilities increased to £627 billion at the end of November from £600 billion a month earlier, driven by falling corporate bond yields. However, this was offset by asset values rising to £658 billion during the month from £629 billion.

“The aggregate funding position on an accounting basis appears to have stabilized following the aftermath of the events at the end of September,” Matt Smith, principal at Mercer, said in a statement. “However, many pension schemes are likely to be working through the next steps in relation to both their investment strategy and their broader funding plans.”

Smith added that next steps for pension will include considering The Pensions Regulator’s recent statement stressing the importance of sensible collateral and liquidity management within workplace plans. TPR said that when U.K. government bond prices plummeted, sending yields to 10-year highs, it exposed shortcomings in LDI funds’ resilience and raised liquidity issues for many plans.

“The Pensions Regulator’s recent statement confirms the need for increased focus and tolerances on LDI, as well as strong governance,” Smith said. “But pleasingly they have retained a flexible framework for schemes to work through sensibly.”

Meanwhile, in the U.S., the aggregate funding level of pension plans sponsored by S&P 1500 companies decreased an estimated 2% during November to 107%, which Mercer attributed to declining discount rates that were partially offset by rising equity markets. As of the end of November, the estimated aggregate surplus decreased to $110 billion from $133 billion at the end of October.

“Equities charged forward in November on favorable inflation news and anticipation that the Fed may begin to slow interest rate hikes as early as December,” Scott Jarboe, a partner in Mercer’s wealth business, said in a statement. “However, with signs of an inflation peak, discount rates fell almost 60 [basis points] in November, which increased liabilities significantly, resulting in a net drop in funded status.”