2017 Capital Market Outlook Mid-Year Update
At the end of 2016, we described several themes which we believed would be important topics for investors in 2017 in our Insight titled “2017 Capital Market Outlook.” As we near the halfway point of the year, we thought it would be useful to provide an update on those themes. In this paper we will also touch on one new theme which we believe is relevant for the remainder of the year.
An Exploration of China A-Shares
To date, institutional investors have been able to access only part of the Chinese equity market through “H-shares”, mainland companies that are traded in Hong Kong. China A-shares, local-currency shares traded on the domestic exchanges in China, are not included in the MSCI Emerging Markets Index and are largely restricted from foreign investment. Given our support of emerging market equities as a component of many investment programs, coupled with China’s increasing importance in the global investment landscape, Rocaton believes it makes sense to study the China A-share market in more detail.
This Insights explores the rationale for; the accessibility of; and the risks of investment in China A-share companies. While we do not offer an opinion on the absolute or relative attractiveness of China as a country, here as elsewhere we do encourage the most robust alpha opportunity set in equities for active investment managers. Rocaton’s view is that active emerging market equity managers should fully consider the China A-share opportunity set for client portfolios, as they would any other region.
Active Management Philosophy & Implementation
Investors have long-debated the merits and challenges of active and passive investing. The discussions have increased recently due to several factors including fee scrutiny, evolution of passive vehicles, and the challenging performance of many active managers over the past several years. Rocaton believes these discussions are important and complex. In this Insights, we outline our general philosophy on active management and present our approach to building a portfolio of active managers and setting active management expectations.
Reviewing the Primary Roles of Core Fixed Income
Core fixed income exposures, as proxied by the Bloomberg Barclays Aggregate Index (“Aggregate”), are found in many investors’ portfolios. Aggregate exposures tend to serve four primary roles in portfolios including 1) source of income, 2) source of liquidity, 3) capital preservation and 4) diversification relative to risk assets. Recent changes to the Aggregate’s interest rate duration, or sensitivity to changes in interest rates, have the potential to impact these four primary roles. This paper focuses on core fixed income as defined by the Aggregate, as this asset class tends to be an “anchor” in many investors portfolios.
Conservative Options in Defined Contribution Plans
Capital preservation options are widely utilized in DC plans and, in fact, data shows participants can over-allocate to these options. For some, capital preservation is the ultimate “sleep at night” option. For others, it’s a conservative strategy designed to limit risk to principal and preserve purchasing power of assets. There is an evolving spectrum of options in the marketplace to address various participants’ needs and there are several timely reasons why plan sponsors should revisit these options within their plan line-up. This Insights evaluates the most heavily represented Defined Contribution capital preservation plan options and provides a framework for constructing and communicating the most appropriate line-up for participants.
Wag The Dog: Why Investors Should Understand and Care About Tail Risk
As the Boy Scouts’ pledge suggests, “Be Prepared.” Investors should all expect to experience a significant tail event in their lifetime. Too often we hear the commentary that 1-in-100 events occur more often than we expect. Accusations abound that risk models have underestimated the probability of such events. We would suggest that it is our responsibility as practitioners to better define, understand, educate, and use risk models and forecasts to help investors prepare for future tail events.
The Case for Peferred Securities
Preferred securities (“preferreds”) are often overlooked by investors. We believe preferred securities can play a role in most investors’ portfolios as the asset class provides a relatively high level of income. Further, we believe the fundamentals of the underlying issuers are stable to improving, depending on the sector, resulting in the potential for spread tightening. Preferreds have greater credit risk (average credit quality BBB/BB) and volatility than core fixed income and should be considered alongside high yield, bank loans, convertibles, and emerging market debt. While there are some investment challenges with the asset class, which we outline in greater detail in the paper, we believe preferreds are a compelling investment idea in today’s low yielding environment.
Enhancing DC Plan Processes & Outcomes in 2017
As we focus on DC plan priorities for 2017, several key themes emerge. With a backdrop of an uncertain regulatory environment and heightened litigation activity with a significant increase in not only the volume, but also the breadth of claims, 2017 provides an opportunity to double down on fundamentals. In short, this is an opportunity to go back to the basics, revisit process, past decisions and documentation.
2017 Capital Market Outlook
At the end of 2015, we published our first capital market outlook. The second installment of this publication provides a look ahead to 2017 and a review of our themes from this past year. As you will notice, many of our themes are influenced by the recent U.S. election results. The impact of our themes for next year will vary by portfolio, but may impact investors of all types.
Pension Funded Status Levels on the Rise
Since the U.S. election on November 8th, most defined benefit plan sponsors should have experienced a material increase in funded status. This Rocaton Insights piece provides a review of recent market movements which have likely led to improvements in funded status.
U.S. Election Implications
Donald Trump’s victory in the U.S. presidential election was a surprise to many market participants, resulting in increased market volatility immediately following the election. There is a level of uncertainty with this result as Trump has put forward fewer policy specifics than most Presidential candidates. In addition, because he has no experience in government, we cannot look to prior votes or proposals to better understand his views. Despite the level of uncertainty, we believe it is important to take a longer-term view. The balance of this paper will review what we believe to be the critical issues which will drive markets over the coming months and years.
An Introduction to Securitized Credit
Securitized credit (or “structured product”) consists of bonds backed by mortgages, loans, and leases (the “collateral”). It is a diverse asset class that is not well represented within the Bloomberg Barclays (“BB”) Aggregate Index. As such, the asset class is typically underrepresented in institutional investor portfolios. Backed by a diverse range of collateral types, a dedicated structured product allocation may provide investors with diversification benefits, reduction in interest rate risk and an attractive yield. Investors should be aware that a dedicated structured product portfolio may be less liquid, challenging to access, more expensive and difficult to benchmark. This paper discusses the securitization process, opportunity set, and implementation considerations.
Do U.S. Presidential Elections Impact Capital Markets?
Every four years, in the months leading up to the U.S. presidential election, we often get asked how capital markets will react if the Democratic or Republican candidate wins the election. It is easy to assume that the U.S. election will have a big impact on capital markets, particularly given the length of the electoral cycle and the coverage by the media. However, historical data seems to suggest that elections do not drive market returns, particularly for those investors with a long time horizon. While we cannot make predictions about the election’s short-term impact on capital market performance, we would suggest clients look beyond the election and stay with their long term investment plan.
Emerging Market Debt Revisited
Emerging market debt (“EMD”) has become more widely adopted by investors in recent years, partially as a result of the strong performance the asset class has experienced over the long-term. Additionally, the credit quality of the EMD USD denominated benchmark has improved over the last 15 years, even in spite of recent downgrades (e.g. Brazil). Beyond the strong performance and improving credit quality, there is also a growing list of strategies which investors can choose from leading to increased adoption. We believe EMD investors should make use of a wide opportunity set, but utilize a U.S. dollar-denominated benchmark. In our opinion, most investors should implement via opportunistic strategies or hard currency strategies which make use of hard currency bonds as well as local currency and corporate bonds. Blended mandates which have a neutral allocation of 50% local currency, in our opinion, require accepting too much volatility and uncertainty around the direction of the U.S. dollar relative to emerging market currencies. The balance of this paper will detail our rationale for these recommendations, provide guidance on benchmark selection and provide our thoughts on the current outlook for EMD.
Opportunities in a Post-Brexit World
The United Kingdom’s (“UK”) decision to leave the European Union (“EU”) in late June was a surprise to most market participants, resulting in heightened market volatility. In our and many others’ opinion, the vote to leave the EU has increased uncertainty and has not provided any resolutions. While market volatility has subsided in recent weeks, uncertainty remains. Given the high level of uncertainty and unattractive fixed income and equity market valuations, we believe it will be difficult for investors to generate attractive returns in the near term. Interest rates across the globe are at historically low levels and U.S. equity market valuations are elevated. While equity market valuations across non-U.S. developed and emerging markets are more attractive than those in the U.S., the potential for continued political instability and an uncertain economic outlook present challenges. The balance of this paper provides additional color on our capital market return forecasts and reviews potential investment opportunities which investors may wish to consider.
Overcoming Challenges in the 403(b) Tax Exempt Market
In 2007, the IRS issued regulations that effectively made 403(b) plans more similar to 401(k) plans. The regulations had a dramatic impact on 403(b) plans, resulting in (1) greater focus on fiduciary oversight, (2) improved investment lineups, and (3) consolidated administrative platforms (i.e. recordkeepers/vendors). Despite these changes, in many ways the 403(b) market continues to differ meaningfully from the 401(k) market. The balance of this paper highlights the “then” and “now” with respect to these three main areas, and offers Rocaton’s key takeaways for 403(b) plan sponsors to consider going forward.
Examining Completion Management for Pension Plans
The term “Completion Manager” has become part of the pension lexicon for plan sponsors and long duration asset managers over the past several years. However, the term is not easily defined given that completion mandates vary widely in terms of their scope and objectives. This Insight piece will seek to define completion management and discuss the potential role(s) a completion manager can play, evaluate the appropriateness/usefulness of a completion mandate relative to the incremental cost and complexity, and identify characteristics necessary to execute completion services effectively.
2016 Capital Market Outlook Mid-Year Update
At the end of 2015, we described several themes which we believed would be important topics for investors in 2016 in our Insight title “2016 Capital Market Outlook.” As we near the halfway point of the year, we thought it would be useful to provide an update on those themes. In this paper we will also touch on two new themes which we believe are relevant for the remainder of the year.
Low Volatility Equity Investing
Low volatility equity investing, sometimes considered among the “smart beta” strategies, has garnered a lot of attention and interest in the investment community since the financial crisis of 2008-2009. Low volatility investing is an investment approach with broad applications. Many investors have been searching for ways to reduce the overall volatility of their entire portfolio without sacrificing returns. Low volatility strategies are constructed in order to achieve those goals with the additional benefit of lower fees than traditional active management. Investment managers are able to attain an attractive risk/return profile due to the low volatility anomaly that exists in the stock market. This paper will provide insight into the low volatility anomaly, objectives, expectations, and client fit of low volatility strategies.
The Case for a Strategic Allocation to Long Treasury Bonds
Investors often have strong opinions, either positive or negative, about the use of long duration Treasury bonds within a portfolio. While many defined benefit plans make use of long Treasury bonds for hedging purposes, we also believe that total return investors can benefit from a strategic allocation to the asset class. More broadly, we believe this asset class can and should play a role in a long-term portfolio that has significant exposure to risk assets (e.g., equities and credit). When implementing a long Treasury allocation, we would not suggest moving to that allocation in its entirety immediately, but rather over time. This paper will review the properties of long duration Treasury bonds, examine the role of fixed income in a portfolio, discuss the implications of rising interest rates and evaluate the merits of long Treasury bonds in a portfolio.
Energy Market Opportunities
The decline in energy markets over the past 18 months has been dramatic with crude oil prices falling 70% and natural gas prices falling 60%. When a market experiences a severe correction, we believe it is appropriate to look for attractive investing opportunities in that market. Some of the areas which we believe present attractive opportunities today include private energy investments and midstream energy debt. To be clear, these opportunities do not rely on a significant rise in energy spot prices to generate attractive returns. The balance of this paper details our views on the following energy investment opportunities, Long-Biased Energy Futures, Energy Public Debt, Energy Public Equities, Master Limited Partnership Equity, Master Limited Partnership Debt, and Private Energy Partnerships.
Are Negative Interest Rates Headed to the U.S.?
Just two months after the first U.S. interest rate hike in nearly a decade, there has been a meaningful increase in commentary surrounding the potential for negative interest rates in the U.S. Outside of the U.S., negative interest rates have been around for several years and many developed country bond markets have parts of their yield curve in negative territory. Although the potential for negative interest rates in the U.S. seemed implausible just a few months ago, we believe the possibility should not be dismissed. To be clear, the focus of this paper is on the possibility of negative rates at parts of the Treasury yield curve as opposed to negative policy rates as set by the Federal Reserve. The balance of this paper will detail several reasons why we believe U.S. interest rates could head lower, outline what investors should expect in a prolonged low interest rate environment, and examine how investors can position their portfolios going forward.
Diversified Multi-Asset Strategies in a Defined Contribution Plan
Investors of all types are currently faced with an environment that is marked by relatively expensive assets and low return expectations. This is particularly true for Defined Contribution participants where plan lineups are often dominated by traditional fixed income and equity exposures. One potential solution to this issue is to consider adding a diversified multi-asset strategy to a plan’s lineup. In short, these strategies target positive real returns (typically, 3-5% over inflation) with modest levels of expected risk (typically, less than half that of public equities). The balance of this paper will review the characteristics of these strategies, provide a comparison to more traditional real asset strategies and outline some of the considerations plan sponsors should understand.
2016 Capital Market Outlook
As 2015 draws to a close, investors are starting to turn their attention to 2016. We thought it would be useful to describe some themes which may be important topics for investors in the coming year. The themes we explored in further detail throughout the paper are Global Growth, Europe, Fed Rate Hike(s), Search for Return, Energy Market Uncertainty, and Bond Market Liquidity. The impact of these issues will vary by portfolio, but investors of all types should have some takeaways.
2015 Survey of Defined Contribution Viewpoints
Rocaton Investment Advisors and Pensions & Investments conducted a survey to gather the perspective of over 400 Defined Contribution plan sponsors and industry professionals at asset management, recordkeeping and consulting firms. These real-time insights can help inform plan sponsors and others of the potential direction in which the industry may be headed regarding a variety of topics and shed light on changing viewpoints and emerging best practices. By polling both constituencies, it allowed us to directly compare and contrast the viewpoints of plan sponsors and industry professionals.
Emerging Markets: Compelling Long-Term Value or Value Trap?
During a strong bull market in which nearly all asset classes have risen in price, there has been one noticeable outlier: emerging markets. Following the global financial crisis, emerging markets appeared to be an attractive investment as these countries were, by many measures, in better fiscal health relative to the developed world. However, the experience for investors allocating to emerging markets, particularly equities and local currency debt, has been anything but satisfying. Emerging market asset classes, primarily equities and local currency debt, have declined significantly in 2015 and have struggled to keep pace with developed market assets for much of the last five years. There are significant risks and opportunities in emerging markets resulting in the potential for a wide range of outcomes.
An Overview of ESG Investing
Environmental, Social and Governance (“ESG”) investing is a broad label currently employed by firms and strategies that consider various environmental, social, and/or governance factors when making investment decisions. A recent study by the CFA Institute notes that 73% of investment professionals take ESG issues into account in their investment analysis and decisions. In this Rocaton Insights, we review trends in ESG investing, outline various investment approaches for ESG investing and highlight some of the primary fiduciary considerations that investors must be aware of when selecting ESG strategies.
Equity Market Valuations: A Review of CAPE Ratios
There is no perfect measure for assessing the value of public equity markets, but the price-to-earnings ratio is both logical and certainly one of the most popular metrics. Rocaton prefers to use cyclically adjusted price-to-earnings (“CAPE”) ratios, sometimes referred to as normalized P/E ratios or the Shiller P/E ratio. While we don’t expect CAPE ratios to have perfect predictive power, the measure has proven to be reliable over longer time periods. In this Rocaton Insights, we review the predictability of CAPE ratios, address some of the criticisms of CAPE ratios, and examine where current equity market valuations are today.
Bulk Terminated Vested Lump Sum Offerings
Over recent years, lump sum offers to terminated vested participants have gained popularity as a pension de-risking initiative. This is largely because of a greater focus on reducing overall pension risk by plan sponsors, regulatory changes, and to some extent market conditions. In this Rocaton Insights, we seek to help plan sponsors understand the potential reasons for a terminated vested lump sum program, the effects such a program can have on key pension costs and measures, and the potential changes in a plan’s risks after the program is executed.
Money Market Reform: An Update for Defined Contribution Plans
Last year, the Securities & Exchange Commission approved amendments to Rule 2a-7 of the Investment Company Act of 1940 which governs U.S. money market funds. Shortly after the announcement, Rocaton circulated a memo to clients summarizing these reforms and noted that investors should revisit the objectives and risk tolerance for their money market vehicles, especially those invested in prime money market funds which are most affected by the new amendments. This Rocaton Insights provides an update on this important topic.
Incorporating Alternatives in an LDI Growth Portfolio
Many pension plan sponsors following a liability driven investing (“LDI”) approach have split their portfolios into hedging assets and growth assets. Typically, public equity strategies have constituted the vast majority of growth portfolios. Historically, alternative investment strategies have demonstrated an ability to meaningfully enhance the risk/return profile of a long-only equity allocation. In this Rocaton Insights, we detail several alternative asset classes which may be appropriate for inclusion in an LDI growth portfolio.
Currency Hedging: Is It Worth It?
Most U.S. investors invested in foreign markets do not have long term strategic policies in place to hedge currency exposures arising from non-U.S. equity investments. For a variety of reasons, we decided to review the topic of currency hedging. While there are reasons investors might want to hedge their currency exposure on a strategic basis, we generally believe investors should maintain their unhedged developed international equity exposures. This Rocaton Insights provides a more detailed discussion of Rocaton’s views on hedging currencies.
Custom Target Date Options: A Higher Hurdle
Given the high utilization of target date options in defined contribution plans, target date options are receiving ever greater scrutiny. As such, custom target date options are becoming a more popular discussion topic. While there are many factors that could lead a plan sponsor to seriously consider custom target date options, we believe there are a few key considerations that should receive the most weight when considering custom target date solutions. We suggest that there should be a higher hurdle for custom implementation and we outline a number of considerations for custom target date options in this Rocaton Insights.
Liability-Driven Investing Principles for Pensions
Liability-driven investing (LDI) for corporate pension plans can take on many flavors. At its most basic, it simply represents a framework whereby the sponsor views, assesses, and invests assets in the context of liabilities. This Rocaton Insights addresses a number of topics related to the LDI framework and explains, at a high level, a number of Rocaton’s LDI philosophies.
15 in '15: 15 Considerations for Your DC Plan in 2015
Rocaton has compiled a list of our top 15 considerations for Defined Contribution Plan Sponsors to contemplate over the course of 2015 and beyond. Some topics are potentially time-sensitive items that could be addressed this year, while others are longer-term suggestions. Not every item may be appropriate for all plans, and clearly prioritization of these items relative to the needs of each plan is appropriate. This Rocaton Insights covers these 15 considerations in more detail.
Expanding the LDI Tool Kit: Alternatives to Long Corporate Bonds
Along with long government bonds, long corporate bonds have been the predominant asset class that plan sponsors have used in an effort to hedge their pension liabilities. Although long corporate bonds may be well suited to hedge pension liabilities, hedging is an imperfect exercise for a number of reasons. In this Rocaton Insights, we explore other long duration assets that may serve as a complement to plan sponsors’ current LDI programs.
The Impact of Falling Energy Prices
The recent decline in energy prices has been significant as crude oil prices have fallen more than 40% from their 2014 peak levels. Investors should be aware that diversified portfolios have implicit exposure to the energy sector in nearly every asset class and not exclusively asset classes which are directly invested in crude oil futures or energy businesses. This Rocaton Insights reviews the implications of the fall in energy prices, examines investors’ potential exposure to the energy sector and revisits our thoughts on the commodities futures market.
Exchange Traded Funds: Institutional Investors' Friend or Foe?
Exchange traded funds (ETFs) have been around for more than two decades and recent growth in this market has been impressive. However, adoption by institutional investors (defined as pensions, endowments, insurance general accounts, defined contribution plans, etc.) has been modest. This Rocaton Insights provides an overview of the ETF market and seeks to identify ways in which institutional investors might make use of these products.
Misery had Plenty of Company: Active Equity Manager Performance in 2014
In this Rocaton Insights, we discuss the widespread relative underperformance of active equity managers during the first half of 2014.
PBGC Variable Rate Premium Methodology Determination
In light of 2014 savings, many corporate plan sponsors are currently faced with a decision regarding the liability discount rate methodology they will use to determine the Variable Rate Premium (VRP) payable to the PBGC for the 2014 plan year. In this Rocaton Insights, we explain the key considerations and possible implications of this decision.
Bond Market Liquidity
Fixed income market liquidity, defined as the ability to transact in the market without affecting the asset’s price, has always been varied. This disparity in liquidity presents both opportunities and challenges for investors. Potential challenges stemming from bond liquidity have risen as evaporating market liquidity could cause prices to fall rapidly and sharply in the event of a market correction. This Rocaton Insights explores current liquidity conditions across fixed income markets and the potential implications for investors’ portfolios.
Pension "Smoothing" - The Highway and Transportation Act of 2014
On August 8, 2014, President Obama signed into law the Highway and Transportation Funding Act of 2014(HTFA). This legislation theoretically helps to fund the Highway Trust Fund by reducing corporate pension contributions, which are tax deductible. Required pension contributions will be reduced by extending the interest rate stabilization provisions that had been introduced by the Moving Ahead for Progress in the 21st Century Act (MAP-21).
Investing in a Low Return Environment
Over the last five years, capital markets across the globe have rewarded investors handsomely. Unprecedented monetary stimulus from central banks around the world has lowered interest rates and boosted equity markets. This has led to a scarcity of attractively priced assets and lowered future return expectations for most asset classes. As a result, investors may be asking themselves how to position their portfolios. The balance of this Insights will describe potential routes that investors might consider including moving to a more defensive positioning, hedging against downside outcomes (i.e. options or tail risk management strategies), increasing portfolio risk to compensate for low expected returns or maintaining existing allocations.
The Most Important Price in the World: U.S. Interest Rates and the Impact on Asset Allocation
Global financial markets have rallied in the last five years, due in part to easy monetary policies. As a result, future return expectations for many asset classes are modest given low starting interest rates and elevated equity market valuations. Investors may want to reposition their portfolios to exploit some of the limited market opportunities that exist, be positioned at or possibly even below target risk levels and be prepared to deploy capital during the next market correction.
Playing Defense: Investing in Convertible Bonds
Diversified investors often hold a mix of public stocks and bonds alongside alternatives such as real estate, private equity and hedge funds. Although convertible bonds are infrequently used by institutional investors, they may help improve a portfolio’s return and risk profile. Rocaton first highlighted the benefits of a convertibles allocation in 2006 (The Case for Convertibles, August 2006). The attached Rocaton Insights will revisit our research from 2006, review convertibles’ performance in recent years and outline various active management approaches.
Rocaton/ Pensions & Investments 2014 Survey of DC Industry Viewpoints
Rocaton Investment Advisors and Pensions & Investments conducted a survey to gather the perspective of approximately 450 defined contribution industry professionals at asset management, recordkeeping and consulting firms. These real-time insights can help inform plan sponsors and others of the potential direction in which the industry may be headed regarding a variety of topics and shed light on changing viewpoints and emerging best practices. In this Rocaton Insights we discuss the survey respondents’ views on improving participant outcomes, conservative investment options, custom target date funds, new areas of focus, revenue sharing, as well as the respondents’ own behaviors, and the implications for plan sponsors.
Building a Better Inflation Hedge: The Case for Real Assets
After witnessing the U.S. equity market rally more than 32% in 2013 and experiencing the first negative calendar year for core U.S. fixed income since 1999, investors may find themselves questioning the prospects for returns in traditional stock and bond markets going forward. In addition, continued quantitative easing from central banks around the world has many market pundits predicting the return of inflation in the not too distant future. As we outlined in a recent Rocaton Insights (The Outlook for Treasury Inflation Protected Securities, November 2013), inflation linked bonds may not provide the inflation hedge that many investors are expecting. In this Rocaton Insights we discuss potential opportunities in real assets while also outlining various considerations for these asset classes.
High Yield Municipal Bond Outlook
Uncertainty surrounding Federal Reserve interest rate policies and negative municipal headlines related to Detroit’s bankruptcy proceedings, Puerto Rico’s deteriorating fiscal situation, and Illinois’ pension reform issues made for a volatile 2013 in the retail driven municipal market. While volatility remains, this dislocation has led to a potential investment opportunity, particularly in high yield municipal credits. In this Rocaton Insights we review the characteristics of the municipal high yield market and the potential opportunities that exist.
High Yield: The Merits of Active Management
Active management is widely adopted in fixed income given the over the counter nature of the asset class, the complexity of certain security types, and the differing objectives among the investor base. High yield stands out as an area where skilled active managers have historically delivered strong relative performance. The past five years, however, have been an anomaly, given that active high yield managers of all styles have generally lagged market indices. In this Rocaton Insights we will provide theoretical support for active management within high yield and will delineate possible outcomes for active management moving forward.
The European Distressed Opportunity
For several years, the European debt crisis has inflicted unprecedented stresses on the Continent’s economic and financial systems. Yet, while investment strategies oriented towards distressed European credit and real estate have been available throughout this period, broad-based buying opportunities have largely failed to materialize until recently. Now, as conditions have begun to stabilize, significant deleveraging of the European financial system has begun in earnest. In this Rocaton Insights we will explore the reasons why the time may be right for investors to consider investments in European distressed credit and real estate, as well as key implementation considerations for such strategies.
The Outlook For Treasury Inflation Protected Securities
The continued expansion of the Federal Reserve’s balance sheet coupled with a zero interest rate policy has led many market pundits to speculate that inflation will come roaring back in the not too distant future. Despite the fact that inflation has remained modest for much of their existence, Treasury Inflation Protected Securities (“TIPS”) have continued to deliver strong performance. In the attached Rocaton Insights, we examine the outlook for TIPS and suggest alternatives for investors to position their portfolios to protect against inflation.
The Great Rotation? Implications of the Recent Volatility in Interest Rates
Most financial market commentators have been calling for a secular rise in interest rates for several years only to find interest rates reaching new lows. Is the recent sharp jump in rates the beginning of the secular rise many forecasters have been predicting or is this just another false alarm? In this Rocaton Insights, we review recent Federal Reserve market actions and suggest alternatives for investors to position their fixed income portfolios.
End of the Commodities "Super Cycle"?
Investors allocating to commodities have often cited diversification benefits and inflation hedging properties as two of the primary attributes which make the asset class compelling. While Rocaton still believes a portfolio of commodities can provide these benefits, we are concerned about the prospects for returns in the near- and medium-term. In the attached Rocaton Insights, we review current supply/demand dynamics and discuss our outlook for the asset class.
Emerging Market Debt Update and Outlook
Volatility returned to many fixed income markets during May and June, particularly the emerging market debt market. Through the end of June, heightened volatility remained and performance across all emerging market debt markets suffered. In the attached Rocaton Insights, we provide an update on performance and provide our outlook for the asset class.
The Search for Yield Continues: A Re-introduction to Bank Loans
The low interest rate environment continues to be a concern for many plan sponsors. Bank loans, an asset class that is relatively underutilized by many institutional investors, can offer modest levels of current income with little interest rate risk. The attached Rocaton Insights presents the case for why plan sponsors might want to consider making an investment in this asset class.
PBS FRONTLINE documentary “The Retirement Gamble”
This program was fairly critical of DC plans in general, highlighting issues that have led to instances in which participants were unsuccessful in building adequate retirement savings balances. Although many of the issues highlighted in the program deserve attention, the program also failed to discuss the many positive developments in DC plans over the past few years. The attached Insights summarizes Rocaton’s response to the program and provides some talking points that might be useful in discussions with your DC plan participants.
Reasons to be Optimistic in 2013
As we enter 2013, it is easy to be overwhelmed by negative sentiment on the economy at home and abroad. There is no question that the U.S faces a number of significant economic and political challenges in the years ahead. Also, other regions and countries such as Japan and Europe face arguably bigger problems. The media, however, can tend to look backwards rather than forwards and as a result can miss important developments in the economy. We, at Rocaton, are not economists and this memo is not designed to be predictive. We also are not prone to excessive optimism. But, we would like to challenge certain prevailing opinions and raise awareness of the concept of improving fundamentals rather than the gloom which for some in the media and financial markets has become an obsession.
Returns Wanted! Opportunities in Private Middle Market Lending
Four years after the turmoil of the 2008 credit crisis, continued political and economic malaise has forced monetary policymakers to prolong and enhance their stimulus of capital markets. Yet, as successive waves of monetary stimulus have caused market participants across the board to pursue risky assets in pursuit of yield, a specific set of structural forces at work in the market for corporate credit has caused a bifurcation in the cost of capital for large versus small and medium sized creditors. Currently, the cost of credit for small and medium sized corporate borrowers in the private market is up to 4-5% higher than for large issuers of comparable credit quality issuing publicly traded bonds. For investors with an ability to accept illiquidity, strategies designed to capitalize on this lending opportunity offer an attractive premium over public bond markets. In this paper, we will lay out the options available for investors seeking to participate in private middle market lending. We then turn to a brief exploration of the forces that have created these conditions and why they are likely to persist for some time.
2012 Year in Review: The State of the Corporate Pension Market
Recent years have been eventful in the world of pensions, and 2012 was no exception. While there is much to say about individual events and trends of the outgoing year, we wanted to take this opportunity to briefly summarize those which we believe were most significant.
The Long & Short of It: LDI in a Low Rate Environment
Liability-driven investing continues to be a top priority and an important element in risk manage¬ment for many pension plan sponsors. However, with markets at what appear to be extreme levels and with the passage of legislation which may obscure the benefits of LDI for some sponsors over the next several years, we believe that investors should review existing LDI programs and associated transition plans. Depending on their objectives and circumstances, some sponsors may want to consider the merits of suspending plans to add to long bond allocations. For some plan sponsors, shortening the duration of their fixed income portfolio may also be a possibility.
Fixed Income Investing: What’s an Investor to Do?
As interest rates have fallen steadily over the past 20 years, total-return oriented fixed income investors, such as defined benefit plans, defined contribution plans and endowments, have enjoyed strong fixed income returns with modest volatility. However, as interest rates appear to be headed towards or are at a secular trough and credit spreads are at or near historical averages, traditional core fixed income investors may have to lower their return expectation from this point forward.
Taking the Bite Out of Your Equity Beta
Long-only equity indices have generated tepid returns over the last decade along with heightened volatility. In contrast, many long/short equity strategies have produced higher returns with lower risk over the same period. This paper provides detail supporting Rocaton’s assertion that investors with significant equity allocations should consider the addition of long/short equity strategies as a part of their equity program as a means of improving the program’s risk adjusted returns.
Managed Futures: The Case for a Strategic Allocation
In order to better manage risk in their portfolios, investors should consider expanding their asset allocation “toolkit” to include diversifying investment strategies that may fall outside of the traditional asset allocation framework. Managed futures strategies may offer significant diversification benefits versus most asset classes, an attractive asymmetric return profile, and the potential for alpha generation. While these strategies carry a variety of risks and may not be appropriate for all investors, we believe these strategies should receive serious consideration as part of a “diversifying strategies” allocation, an “opportunistic” allocation, or a hedge fund allocation.
Forward Thinking: Resetting Expectations in the Current Market Environment
While the economic crisis of 2008 and its aftermath remain a painful memory, the global financial market rally over the last two years has helped to alleviate part of the sting. The magnitude of the market's ascent and its resiliency in the face of weak economic conditions in developed countries, the ongoing European sovereign debt crisis, and geopolitical unrest has surprised financial pundits and investors alike. Heightened volatility and risk aversion are beginning to resurface, however, and we believe investors should adjust their performance expectations accordingly.
The State of Stable Value
The intense scrutiny on stable value portfolios has diminished markedly since the credit crisis, as most stable value portfolios have recovered meaningfully. However, in reality, very little has changed in the marketplace, due to pending legislative and regulatory reform, lack of wrap capacity, and the fact that wrap providers continue to exert a significant influence over plans and contract terms. This insight will provide an update on the state of the stable value market.
The Case for Tail Risk Management
How can investors make portfolios more secure in the face of events such as the fall of Lehman Brothers in September of 2008? We believe the answer lies in reevaluating existing asset class exposures and considering all the relevant definitions of risk. We introduce the concept of Tail Risk Management, an investment strategy that is designed with a goal of realizing significant profits in stressed market environments, thereby offsetting market value losses from risk assets.
Performance Challenges for International Small Cap Managers in 2009
The universe of active, long only international small cap equity managers delivered disappointing relative performance versus the MSCI EAFE Small Cap Index in 2009, in marked contrast to the longer term historical record of active managers in this market sector. We review the performance challenges during this period that acted as significant headwinds to this universe of managers.
Extending Bond Duration in Today’s Environment: Is Now the Time?
Liability Drive Investing (LDI) is one of the highest priorities on many corporate plan sponsors’ to-do-lists. Although the process of determining the appropriate long bond allocation and optimal portfolio structure is complex, we evaluate the most common question asked by plan sponsors in reference to LDI: Is today the right time to extend the duration in my fixed income portfolio?
Revisiting Stable Value
Defined contribution plans have long used stable value funds as a capital preservation option among the investment choices offered to participants. We review the basics of stable value funds, current market environment, wrap contract issues, and the results of a Rocaton survey of stable value funds.
Rebalancing Revisited: Is it Time to Trade?
Rebalancing Revisited: Is it Time to Trade? Rebalancing continues to be an important topic on the minds of many investors. We address the questions investors might ask when considering if they should rebalance now.
Emerging Markets Equities: Revisiting the Rationale
Investors have historically invested in emerging markets equities primarily based on the secular growth prospects for the asset class. Since the inception of the asset class, emerging markets have delivered strong risk-adjusted returns. However, in 2008, emerging markets equities have significantly underperformed developed markets equities. We revisit the rationale for investing strategically in the emerging markets, review the relationship between the 2008 decline and past crises, and highlight the fundamental case for growth within the emerging markets today.
A Perspective On Active Equity Management
Global equity markets have experienced significant declines in 2008. We review performance of global equity markets and active managers who invest in these markets and provde some observations.
Can Hedge Funds Redeem Themselves?
There has been much press coverage regarding looming redemptions from hedge funds at the end of 2008. We examine how much evidence there is to support the media coverage of such redmeptions and what that means for the near-term and long-term future of hedge funds.
Have Bricks, Need Mortar: Opportunities in Real Estate Lending
A decline in lending to real estate investors from conventional financing sources, a decline in real estate transaction velocity, and a slowing economy all have contributed to an increased demand for custom financing in the real estate markets. We discuss real estate debt investment opportunities as well as the accompanying risks.
Liability Driven Investing: Liabilities are the Ultimate Benchmark
Volatility in the funded status of many pension plans, changes in accounting and funding rules, and development of the derivatives markets have shifted focus from total return investing to liablity driven investing. We examine the key issues associated with liability driven investing.
Measuring Market Exposure in Hedge Funds
Absoulte return strategies may offer one means for investors to diversify their portfolio risk. We examine the effects of reducing the typically large portion of expected risk derived from equity market exposure by investing in hedge funds.