What are the implications of strategic asset allocation, the dynamics of public and private credit, tech-driven megatrends, and more? Stephen Dover, head of Franklin Templeton Institute, provides some insights gathered from our investment experts.
The Franklin Templeton Institute recently hosted a series of sessions where our specialist investment managers shared their investment insights. Our investment managers broadly agree that 1) recession is likely, but the unique characteristics of the previous pandemic-fueled recession wrung out many excesses. And, it’s likely any recession will be shallow; 2) inflation will come down, but not to the low levels experienced over the past few decades.
Given this global backdrop, our investment experts explored the implications on issues such as strategic asset allocation, the dynamics of public and private credit, tech-driven megatrends impacting society and investing, managing risk in concentrated equity portfolios, and the impact of food security on geopolitical stability.
Here are some of my key takeaways:
- Both equity and fixed income markets can function in environments of 3%-5% inflation, and alpha opportunities often emerge as interest rates rise and stabilize.
- With interest rates now elevated, there is room for monetary policy easing in many parts of the world if there are signs of economic stress. This makes fixed income attractive at current yields, particularly in shorter-duration debt and high-quality corporates. There is a possibility of higher volatility in interest rates over the next year, as the Federal Reserve attempts to regain credibility. But there is an equal chance that the rate path will be smoother than expected, as inflation will subside on its own. Because of this uncertainty, focusing on factors such as credit quality may be prudent.
- Private real estate generally benefits from higher inflation and enjoys tailwinds as the combination of rising e-commerce and supply chain realignment toward “just-in-case” inventory management favors continued growth in industrial warehousing.
- Higher interest rates have helped lead to a higher US dollar, which is likely to persist if there is uncertainty on the magnitude of the global slowdown. The safe-haven status of the US dollar does not necessarily match the US macroeconomic situation, so any shift in sentiment could allow other currencies to appreciate. The Japanese yen is particularly interesting, as Japan is expected to be the fastest growing country in the G7 in 2023.
- The direction of the dollar will heavily influence emerging markets. Most global investors under-own, undervalue and underestimate the asset class. The quality of the household, corporate and sovereign balance sheets, combined with accelerating exposure to innovative sectors (i.e., semiconductors and biotechnology), creates potential opportunity.
- Quality is also a key theme within both private credit and private equity. A focus on better debt covenants and favorable deal structures in private credit reflects this. Secondary Limited Partnership (LP) interests within private equity allow investors to participate in the upside of a private investment with minimal exposure to the risk of the early stages of a company’s life, which is particularly attractive as macroeconomic volatility remains elevated.
- Looking longer term, the megatrends around the changing face of asset management will lead to more personalized portfolios, an expanded set of manageable assets, and new niche and specialty marketplaces. Experience in building these architectures can be shared through advisory services to clients, including portfolio construction that better incorporates alternative assets.
The impact of sustainability, the influence of early-stage companies on disrupting traditional finance, and the evolution of infrastructure investing, were also key parts of the agenda. The level of complexity in assessing the impact of all these interrelated factors has increased. In trying to absorb the “new normal,” capital markets have re-priced assets in ways that create a more balanced picture between equity, fixed income and alternative options.
I hope these insights from our investment managers help you in better understanding where the best opportunities may lie.
Originally Posted November 3, 2022 – Quick thoughts: The search for hidden opportunities
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