This is the second article in our OCIO Focus series. To read related articles, click here.
As markets rebounded from a March nadir North Pier Search Consulting continued to canvass OCIO market leaders on their perspectives and expectations as well as actions taken on behalf of clients. In this piece we share insights from Angeles Investment Advisors, Hirtle Callaghan, and NEPC on their approach to the markets and how their diverse client bases are responding to the pandemic.
The Past 90 Days
The first half of 2020 has provided market participants with unique opportunities. The historic collapse in asset prices in late February and early March reversed with similar vigor. Many OCIO managers were well positioned to capitalize on these dislocations via the superior agility these structures offer when juxtaposed with typically slower and more bureaucratic committee-led approaches.
Opportunistic rebalancing was a theme that came up time and again in our conversations. “It’s not often you get lucky like that…but we hit the rebalance button twice in March and pretty much hit it right at the trough, which was great,” said Steven Charlton of NEPC. Michael Rosen of Angeles Investments added, “In the beginning of March we raised a bunch of cash in portfolios and then by the end of March had it deployed. And so at the beginning of the second quarter we were basically right on our long-term asset allocation targets, fully invested and that hasn’t really changed.” These comments underscore why more institutions are considering the OCIO model, the flexibility to take decisive action within the IPS mandate can make all the difference in a world where investors remain starved for yield.
Some managers opted to capitalize on the market turmoil via strategies that less sophisticated investors may not consider or have access to. Mark Hamilton at Hirtle Callaghan detailed how his firm had allocated to covered option writing strategies intended to harvest some of the significant volatility premium that emerged during the height of the panic. The ability to harness unconventional strategies that profit from mechanical selling or forced deleveraging in the financial system is yet another tool in the toolbox that allow OCIOs to improve client outcomes.
Where We’re at Now
With a full quarter of capital market recovery under their belt, how are OCIOs currently maneuvering? For NEPC, the viewpoint is, “lots of caution,” says Charlton. “Things are pointing to the W shaped economic recovery instead of the V,” he continues. “The markets have overcooked things…but we think the Fed will do a ton to keep the markets going. That gives us a level of comfort that things won’t fall apart. So, we’re neutral to negative on the markets right now, maybe a slight underweight because we do think that W will come along.”
Hamilton notes that Hirtle Callaghan doesn’t think the credit markets have healed, “so we’re not interested in going back into public high yield or syndicated bank loans. Wouldn’t touch them.” On the private side, their initial thoughts were defensive, but that thinking has evolved to “play more in distress or rescue financing – increasing that exposure almost 50% of the private debt,” says Hamilton. At Angeles Investments, they have a big overweight to growth over value, large cap over small cap, and US over non-US. “We continue to have a very high conviction in the growth over value theme. I think that’s got legs,” notes Rosen.
What Does the Future Hold?
Rosen may have put it best: “The crystal ball is always cloudy.” With that said, North Pier was able to identify a few thematic constants from our recent discussions. Several of the OCIO managers we spoke with indicated they favored domestic US equity exposure versus developed international. “We’ve had a bit of an overweight to the US certainly relative to international developed and emerging markets… positioning the portfolio is more a reflection of looking at the different underlying markets, the more cyclically exposed markets that you have in Europe versus in the US with the ability of the large cap growth names to ride this out,” said Hamilton.
Angeles Investments referenced the relative tech, healthcare and communications services overweight of the US equity markets as a “structural tailwind.” Managers also indicated an increased interest in private credit exposure, particularly when compared to publicly traded credit. Charlton was quick to point out that in the high-yield bond space, the underlying exposures to certain industries may not be priced attractively, adding that NEPC “thinks private lending is still a better place to be, especially for the patient investor.”
In the wake of the 2008-2009 Global Financial Crisis and implementation of post-crisis regulation, it is now apparent that much of the leverage that used to reside on banks’ balance sheets had migrated to private market finance vehicles. This is certainly one reason that the Fed has intervened so aggressively in the credit markets. It does however pose a problem for investors; with publicly traded credit apparently “priced to perfection” risk-adjusted returns on a go-forward basis are likely going to be sub-par. Active management in private lending is a likely beneficiary.
Managers were also able to provide North Pier with some insight into the operational challenges their clients have been facing. Near term cash flow issues were top of mind. One of the managers we consulted highlighted their ability to stress test client portfolios by running scenario analysis to help their foundation clients evaluate the long-term impact of stepping up grant making to meet immediate crisis needs.
Healthcare systems and institutions of higher education are feeling the full brunt of the crisis. Surprisingly “the level of optimism is higher than I would have thought,” says Charlton on how some of NEPC’s healthcare clients are coping. “Of course, you can’t ignore the near-term issues – they’re laying people off and the level of stress that the systems are going through is clearly large. But when speaking with clients on their longer-term views, in the end, people are going to come back to hospitals for procedures currently on hold, like elective surgeries. That was really interesting to hear.”
The COVID-19 crisis is exactly the type of challenge that institutional investors hired OCIO managers to navigate. When the dust settles, there will likely be a wave of prospective clients looking to make the transition. The opportunities presented in this unique time will allow the best managers to prove their value, by generating returns and providing their clients with vital operational support and governance leadership.