After a crushing 2022, some portfolio managers at Capital Group are seeing brighter days ahead, despite the many uncertainties that remain for investors in 2023.
Just how bright, and how quickly the clouds part, is hooked very much on the movements of the Federal Reserve, they said yesterday at a webinar to reveal the firm’s asset allocations for this year.
“The key is inflation, and the path inflation takes from here is really going to determine what the macro environment looks like, what happens with interest rates here in the U.S., and then how aggressively the Fed is willing to combat that inflation if it stays somewhat elevated,” said John Queen, fixed-income portfolio manager.
Since the global financial crisis, inflation has remained steadily low, so the Fed only had to worry about employment, and could keep interest rates low for the inflation rate and in tune with what was going on in the economy, he said.
That obviously has changed.
“My own view is rates will continue to rise somewhat, but not aggressively like we’ve seen over the past year. And they will stay at a somewhat higher level than they currently are, and higher than the market is expecting,” Queen said.
The adjustments that the Los Angeles-based Capital Group is making to its model portfolios are small, but tilting away from growth and more toward income, the panel said.
For example, for its growth and income model portfolio, the firm moved 5% of its allocation out of a balanced fund and into a diversified fixed-income fund. And for its conservative income model portfolio, Capital Group moved 4% out of a balanced fund, 1% out of a strategic bond fund and 5% out of a short-term bond fund, and plowed that into an intermediate bond fund and the diversified fixed-income fund in equal amounts.
“From a top-down perspective we brought down equity a little bit,” said Samir Mathur, a solutions portfolio manager at the firm, adding that last year the firm reallocated 8% of its equities into fixed income. “There are other exposures as well in our portfolio that are reacting to the changing market environment.”
For example, Capital Group has been edging off its growth style exposure since it peaked in mid-2020, he said.
The capital market assumptions going forward are long term in nature—20 years out or longer—and not intended to inform tactical tilts in the present, said Michelle Black, another solutions portfolio manager at the firm, but the investment managers do have the flexibility to respond to immediate concerns by tweaking exposure according to geography, market cap or tilts within equity and fixed income.
For a 20-year horizon, the starting point matters, she said, and starting after a down year means positive outcomes for long-term investors.
“It’s probably not surprising to hear we have higher expected returns across the board versus one year ago, stemming really from more attractive valuations, especially in fixed income,” she said. “This is good news given that we’re expecting slower growth in most developed markets around the world.”
Those assumptions are 7.2% for U.S. equity, 7.1% for non-U.S. stocks and 9% for emerging market stocks. On the fixed-income side, the assumptions are 4.2% for U.S. Aggregate bonds, 3.6% for TIPS and 6.6% for U.S. high-yield.
“You have to look at this in conjunction with volatilities and correlations between asset classes when you build portfolios; you can’t just look at return alone,” she said. “But for investors or retirees with sizable fixed-income allocations and a lower tolerance for risk, while 2022 was painful, I do think things will look brighter from here.”
The Capital Group panelists said they look at assets as belonging to three distinct categories depending on what clients’ objectives are: Do clients want to build wealth, spend it or preserve it? For each of those category objectives, the managers take into account such factors as return, risk-adjusted return, volatility, yield and drawdown, and these are weighted as either primary or secondary for each category.
When clients are building wealth, the metric of success for the chosen securities is the long-term growth of capital, they said. When it comes to spending wealth, the long-term growth of capital and income get more attention. And for preserving wealth, the metrics are current income with capital preservation.
Put it all together, and Capital Group has a total of nine asset allocation mixes projected for 2023, three for each category.
Clients who are building wealth can choose from these allocation buckets: global growth (which includes 49.1% U.S. equities, 44% non-U.S. equities, 0.1% non-U.S. bonds and 6.8% cash and equivalents); growth (which includes 71.2% U.S. equities, 21.2% non-U.S. equities and 7.6% cash and equivalents); and moderate growth (which invests 62.9% in U.S. equities, 24% in non-U.S. equities, 4.9% in U.S. bonds, 2% in non-U.S. bonds and 6.2% in cash and equivalents).
Those clients who are spending their wealth can opt for growth and income (including 54.3% in U.S. equities, 20.7% in non-U.S. equities, 17% in U.S. bonds, 2.5% in non-U.S. bonds and 5.5% in cash and equivalents); moderate growth and income (which allocates 45.8% to U.S. equities, 18.9% to non-U.S. equities, 24.9% to U.S. bonds, 5.2% to non-U.S. bonds and 5.2% to cash and equivalents); or conservative growth and income (whose allocation is 35.8% U.S. equities, 10.7% non-U.S. equities, 40.2% U.S. bonds, 7.4% non-U.S. bonds and 5.8% cash and equivalents).
And clients who are in the phase of preserving wealth can choose from conservative income and growth allocation (which puts 27.2% in U.S. equities, 7.5% in non-U.S. equities, 50.8% in U.S. bonds, 8.3% in non-U.S. bonds and 6.2% in cash and equivalents); conservative income (with an allocation of 16.4% U.S. equities, 2.8% non-U.S. equities, 66.8% U.S. bonds, 7.7% non-U.S. bonds and 6.2% cash and equivalents); and preservation (whose allocation is 86.2% U.S. bonds, 7.9% non-U.S. bonds and 5.9% cash and equivalents).
“The success metrics we use will depend on the life stage of the investor,” Black said. “For someone who might be early in their careers, seeking to build wealth, then sure, returns may be the primary driver of success. And we’ll also look at risk-adjusted returns. What kind of risk did you have to take in order to achieve that wealth? And obviously, the lower the volatility, the lower the risk, the better.”
But an older investor who is getting ready to retire may be equally as concerned with managing their portfolio for volatility and income, she said, referencing a Capital Group survey finding that while the median planned retirement age was 65, the median actual age of retirement was 62.
“If you may be one of those people who retires earlier than planned, it’s really important to mitigate that volatility of your portfolio and have income that you can rely on,” she said. “That’s what matters when someone can no longer replace their wealth in retirement.”