Last year, as the world sheltered in place and the pandemic rattled markets, we began publishing excerpts from our conversations with leading providers in the OCIO space in an effort to provide helpful insight and thought-provoking projections. We are looking forward to continuing those discussions in 2021 while simultaneously broadening our coverage.
Most recently we spoke with Bank of America, BlackRock, and Cambridge Associates. As we approached year-end and the start of 2021, we asked each of the aforementioned OCIOs to recount how they navigated the tumult and added value for their clients, as well as what they expect moving forward.
Things looked good entering 2020. An accommodating Fed had cut rates several times in 2019 in an effort to stave off the end of the business cycle. It appeared to be working; employment continued to rise, and problematic inflation had failed to materialize. Matthew Hoehn, Director at BlackRock, described the setup well; “We entered 2020 with a pro-risk stance, our fundamental view was that we were in the latter stages of what had become the longest cycle in U.S. history with fairly tepid growth and stretched valuations.” Several of the other managers we spoke with indicated they were also approaching the market with an appetite for risk. Pre-COVID positioning was relatively consistent as well with managers remaining equity overweight and tilted towards the U.S., continuing to ride a trend that had worked well in recent years.
On January 21st a Washington state resident tested positive for the coronavirus registering the first domestic case. Less than a month later, on February 19th the S&P 500 closes at an all-time high. The implications of the emerging pandemic were largely ignored or downplayed by most market participants and the Trump administration. Even the professionals were caught off guard. One of the managers we spoke with characterized their initial reaction; “What we got wrong in the initial stages of COVID is that frankly we underestimated it, we thought it would be more regional in its orientation.”
As we’ve highlighted all year, unprecedented volatility in the first and second quarters provided nimble managers with a unique opportunity to earn their keep. Our contacts shared some of their real-time portfolio management decisions, including David Koh, Managing Director within GWIM Chief Investment Office at Bank of America: “For a moderate reference portfolio we saw equity allocations decline to approximately 55% in March 2020. On March 19th, we made the decision to rebalance back to our then tactical target of approximately 63%.”
While the COVID drawdown was viscous, it was certainly short-lived. Fewer than three months after the March 23rd trough the S&P 500 had nearly recouped all losses. The second half of the year (and continuing into early 2021) has been characterized by right-tail risk, as markets accepted any and every excuse to surge higher. We hear from managers time and again how crucial the policy response was to engineering a positive outcome: “One element that we were able to capitalize on that was very beneficial for portfolios was that the Fed made the historic announcement in the third week of March that they were going to go out and buy corporate bonds for the first time. That was a clear signal to us that spreads were going to tighten very quickly. We basically moved a good portion of our government bond exposure over to credit at that time,” says BlackRock’s Matthew Hoehn.
The importance of fiscal policy cannot be understated, either. Two consecutive years of deficit spending in the range of 15% of GDP is unprecedented in peacetime. While this borrowing is helping the economy to bridge the gap, much of the spending is being utilized to maintain current levels of consumption, as opposed to investing in the productive capacity of the economy; it remains to be seen what the longer-term economic effects will be.
There is, however, a growing consensus that such an aggressive policy will entail a weaker USD. In our discussion with BlackRock they pointed out that emerging markets (EM) performance is largely explained by dollar strength or weakness. Relative interest rates have driven the dollar higher in recent years, with that headwind largely removed, the group is bullish on both EM equity and fixed income. One manager we spoke with mentioned they were particularly positive on Chinese A-shares, with EM macro tailwinds plus Asia’s impressive pandemic response, and think EM Asia continues to make sense for investors.
Bank of America’s GWIM Chief Investment Office also shed some light on how they were thinking about adjusting their portfolio management activities to a COVID environment and “new normal.” The group has been placing added emphasis on thematic trends they have identified, many of which were accelerated by the impact of the pandemic. Technology and healthcare are particular areas of focus, with David Koh pointing out how artificial intelligence, robotics, cloud computing, cybersecurity, medical infrastructure and “med-tech” would be important areas for the foreseeable future.
Markets continue to build on last year’s recovery early in 2021. Renewed fiscal support, accommodation from the Fed, and the vaccine rollouts are all feeding the bull. There was a general agreement amongst the managers we spoke with that market returns are expected to moderate.
BlackRock also offered insight into how some of their clients are approaching what appear to be fully valued markets; “We have seen a shift in some of our clients asking for more liquid portfolios, what happened in March and April has prompted some of those discussions. We’re also fielding inquiries around customer portfolios using high yield to enhance income as the whole fixed income universe is starved for yield,” said Olaolu Aganga, Director at BlackRock.
Low return prospects and liquidity concerns are significant issues for institutional investors and OCIO providers are well positioned to aid clients in developing solutions. If these solutions work for a particular client, or group of clients, they can often be deployed across the customer base to great effect. An institutional investor operating alone typically doesn’t have the luxury of as many data points or breadth of market research from to draw conclusions. As we progress further into the first quarter, we’re seeing continued interest in the OCIO space, particularly from DB investors. 2020 proved to be the first real test of a more mature OCIO marketplace. We believe that the industry largely passed with flying colors, but we are looking forward to analyzing the data and backing up that statement with quantitative evidence in future pieces. Stay tuned!