This is the third article in our OCIO Focus series. To read related articles, click here.
What will the world look like on the other side of this pandemic? That is the fundamental question that OCIOs, consultants, and asset managers continue to wrestle with. While COVID has accelerated many of the trends that were in place prior to the onset of the virus, there are certain industries and business models that are likely to be permanently impaired. How do allocators react and plan for a post-COVID landscape?
We explored this question and more in our latest round of conversations with top Outsourced Chief Investments Offices (OCIOs) and institutional consultants, including Commonfund, Mercer, and Wilshire Associates.
OCIO Managers on the Economic Outlook
As we progress through the third quarter, the economic impact from the virus is increasingly evident. Sectors that rely on consumers to congregate in close proximity to one another are under severe strain. Strength in the broad equity indices belies economic activity on the ground, at least in the short-term. To that point, Commonfund’s Managing Director Keith Luke commented, “Certainly the market recovery has been a V. But we expect the economy to be more like a series of rolling Ws. There has been so much economic dislocation in certain industries, with retail probably being the biggest thus far. The stress is there and there’s a lot more to come.” In light of their view, Commonfund indicated to North Pier Search Consulting’s analysts that they had begun reducing allocations to quantitative managers and increasingly favoring more fundamental sector specialists. The rolling W is a compelling thesis that would likely be consistent with some of the challenges being faced by foreign nations in maintaining control over the outbreak as well as recent economic and political developments here in the U.S.
On the state of the labor market, Wilshire Associates’ CIO of Consulting Steve Foresti shared his thoughts: “If you look back at other crises, what tends to happen is you get a big hit to the labor force. You get layoffs, that’s typical, but even when some of those jobs start coming back, they don’t come all the way back…the expectation that we’re going to bounce right back to an unemployment rate anywhere close to where we were I think is unrealistic.” While there remains much work to be done to nurse the economy back to health, Foresti did note that companies are rapidly learning about the maturity and flexibility of their workforce. Necessity is the mother of invention and companies are figuring out how to do more with less…and in different settings.
Tactical Asset Allocation
Coping with COVID is a challenge for everyone, and allocators are making decisions today that will drive client outcomes for years. U.S. OCIO Leader Rich Joseph told us that while Mercer hasn’t made any drastic changes to their long-term capital markets assumptions thus far, systematic rebalancing has allowed many of their defined benefit clients to improve funding status versus their benchmarks considerably. “Our clients should have improvement on funded status versus the broader peer group. The process and our ability to implement it was tested and we’ve come out the other side feeling really good about where we are.”
Foresti detailed how in early April, Wilshire Associates made the decision to shift from an underweight to credit to an overweighted position. While remaining conscious of risk and acting primarily in the investment grade space, they were able to execute with fortuitous timing. “What we did was more in the investment grade world. Our thesis in early April was the Fed was going to do everything they can to protect all of the places they can go. We did have some concerns about their ability to impact high yield, which is why we didn’t act as aggressively there. Obviously that was before the Fed decided to support markets and purchase junk bonds as well.” On a tactical level, Wilshire has favored value over growth for some time, as Foresti mentioned this had been a headwind but it is an interesting point of contention within the investment community. While some proclaim the demise of the value factor to be greatly exaggerated, it remains to be seen what will spur mean-reversion after all these years, or if the reversion will ever come.
Commonfund has recently made it a point to confer with clients on their ability to take on liquidity risk. They believe that for clients who have the ability, assuming liquidity risk and capturing the associated return premium is a highly attractive option in a world of very low rates. “It’s really hard to generate alpha in public equities. Although some of these private strategies are more expensive, we think combining that extra firepower with some allocation to cheaper passive strategies is just a better portfolio,” says Luke. Commonfund had a brief comment on publicly traded credit, as well – “tread lightly.”
Client Insights
On the economic impact across Mercer’s clientele, Joseph stated that, “We’re having very different conversations with our clients – travel, hospitality, and other impacted businesses are trying to decide if they can even maintain their DC matching programs. Higher education is in a world of hurt right now, relative to being able to collect tuition and the added costs of simply keeping the institutions operational. I don’t ever remember being this bifurcated where conversations have become so client specific.” For health systems clients, “The discussions have begun to focus more on capital preservation as opposed to generating outperformance,” says Joseph.
Disparate effects are a theme that we continue to encounter, and one that is playing out in the markets as well. With a significant presence in the higher education space, Commonfund reiterated that these institutions are facing significant stress on the operational side, including keeping students and faculty distanced and providing PPE, among other logistics. “Even with these stresses, most endowment assets are restricted; they can’t just be tapped to cover operating shortfalls,” says Luke. Costs that can’t be covered via endowment distributions need to be made up elsewhere, as evidenced by universities cutting athletic programs and extracurricular activities at a record pace.
Piering Ahead
Summer is ending, colder temperatures are looming, and a pivotal U.S. election is just a couple short months away. When broaching the subject of the election with the OCIOs we spoke to, we received similar responses across the board – it isn’t impacting their allocation decisions. “Elections can really surprise you,” says Luke. “It’s hard to handicap; and for those things we don’t really have great insight on, we generally tend to focus away from letting them influence how we think about the portfolio.”
While the upcoming election is certainly top of mind for many Americans, these leading OCIOs will remain focused on maintaining their strategies and effectively managing investments for their client’s unique needs.