Given the tumultuousness of the current economy, it is time for advisors to re-examine the way they construct their portfolios for the near future, according to Sébastien Page, head of global multi-asset and chief investment officer at T. Rowe Price.
Speaking yesterday at the 11th Annual Inside Retirement: Investment Strategies for Your Clients webinar, sponsored by Financial Advisor and the Money Show, Page said that market conditions mean advisors should not push their portfolio strategy in one direction or the other.
“Now is not the time to take a big risk or a big defensive position,” he said. “It’s not as bad as it looks like, but … with equity premiums so compressed, now’s not the time to take a big position either risk on or risk off.”
Baltimore-based T. Rowe is taking a similar investment strategy, where it is slightly underweight in equities and overweight in bonds.
The portfolio has a six-to-18-month duration and Page said it also includes certain risk-on positions where the valuations are attractive. One area the firm is overweight in is small caps. The S&P SmallCap 600 is trading at rates comparable to those that were seen during the 2008 financial crises, according to Page.
“No one wants to own small caps into a slowdown, and when no one wants to do something in markets, historically it’s a really good buying opportunity,” he said.
The high-yield asset class is another area the firm is focusing on because of elevated interest rates and the impact they have on equities, Page said.
“Because rates have gone up from a relative perspective, equities are pretty expensive; as expensive as they’ve been over the past 10 years,” he said. “To me the risk/return expectation for high yield is higher than for equities, so I’d rather put some risk back in the portfolio through high yield.”
He also discussed ways advisors can modernize the standard 60/40 diversification in their portfolio. Page does not believe the configuration is dead but said it needs modernizing to adjust for interest rate volatility. The first way is to take about 15% of the 40% bond component and put it into liquid alternatives.
These can be strategies that are relative value oriented, whether it's dynamic credit or dynamic global, Page explained. He added that they are also good building blocks and have multistrategy capabilities. Advisors should not push their clients’ assets into just any liquid fund, he cautioned.
“You have to be careful of which liquid alternatives you select because some of them are just selling insurance,” he said.
Liquid alternatives also could be selling puts, which will add direct equity risk to a portfolio, according to Page.
Another way to modernize the 60/40 is by adding hedged equities as a sleeve in the portfolio, as well as a dedicated real asset equity strategy for inflation volatility.
The reason for these portfolio changes, according to Page, is because of what he referred to as “whacky” things going on in the industry. One was that market-implied inflation rates are too low and the second is the fact that the market is dropping from very high levels of growth.
Another is that employment numbers are remarkably strong, with unemployment sitting at around 3.7%, according to Page. The final reason is the significant amount of cash in the system.
During the pandemic, governments provided $20 trillion in global stimulus, which in the U.S. included doubling unemployment benefits, forgiving PPP loans for small business, pausing student loan payments, and sending out about 140 million checks of more than $1,000 each to everyday Americans, Page explained.
The free money resulted in about $4.5 trillion in checking accounts and deposits going into the banking system.
“That is a massive cushion, and you combine that with a strong employment [and] you get a strong consumer,” Page said.
Throughout his discussion, Page gave his thoughts on other aspects of the economy, including the potential for a recession. He believes there will be one but said it will be more mild than deep.
“We’ve gone from the most anticipated recession in history to the most delayed recession in history,” he said.
Page also spoke about interest rates and inflation, which have been prominent on most advisors’ and investors' minds lately. He believes inflation will remain between 3% and 4% for some time, which will impact what the Federal Reserve does about interest rates.
Earlier this week, the Fed decided not to increase rates, but indicated that more increases are coming. Page said he does not think that the industry will see any rate cuts for a couple of years.
“My view is I think the Fed will stay at this level for a while because we need to see what the impact of the rate hikes is going to be over a longer period of time,” he said. “Inflation remains sticky. ... I think rate cuts are unlikely before the end of the year and maybe even in 2024.”