Strategy for All Seasons Flashcards
We’ve come “full cycle”
We’ve basically come “full cycle” in credit markets–from tight credit spreads and low yields to decade-high levels of disruption and chaos and back again. In addition to the incredible toll the pandemic has taken globally, the volatility and economic impact we’ve witnessed in the last 12 months has been massive.
Globally, growth was widely expected to continue in 2020.
Globally, growth was widely expected to continue in 2020. U.S. growth was expected to be slow but likely still lead several other major developed economies. Emerging markets had glimmers of growth but few breakout success stories waiting in the wings. Meanwhile, the world began watching China with growing concern as they worked to combat and contain a new strain of coronavirus.
This wasn’t an overnight change.
This wasn’t an overnight change. We had already been trimming plus exposure and reducing risk for most of 2018 and 2019 as spreads compressed. [Insert sand chart showing plus sector allocations from 2016 through 2019] We were getting paid less and less to take risk and there were willing buyers on the other sides of the trades. We sold into that strength.
Markets reacted strongly
Markets reacted strongly as investors began to try to raise liquidity. It felt like all investors at once were trying to raise liquidity.
These were pretty scary times in the marketplace
These were pretty scary times in the marketplace – they were scary times most places come to think of it. But markets were moving. Fast. The velocity of the market movements, the speed with which the pandemic was spreading, and the dominoes of lockdowns and shutdowns all added to the complexity of the decision making process. We knew that this disruption would upend relative values and offer a wide array of possible investments to consider. We thought this was a perfect environment in which our process could demonstrate its value.
Moments like these really test a team’s process.
Moments like these really test a team’s process. It’s one thing to say “we have an adaptive responsive process which looks to exploit changes in relative value.” It’s another to actually put assets at risk when markets are cratering. Our process is rooted in our six-month outlook. We are continuously asking ourselves, how do we expect valuations to look over the next several months? Do we think spreads will be wider or tighter? Yields higher or lower? Economic data improving or faltering? In March and April of 2020, we sat down for our portfolio strategy sessions and asked each other those questions. For each team member, the answer was that we expected spreads to narrow in from the decade-wide levels to which they had rocketed earlier.
“Do we think things will be better or worse in the next six months?”
“Do we think things will be better or worse in the next six months?” We said - Better. “Do we think things will be just a little bit better or materially stronger from current levels?” We thought - Materially better. “Do we think there is value in moving with conviction now? Or do you get paid to wait and see how things evolve?” We agreed - Conviction matters now.
We found some opportunities in Europe and emerging markets which were attractive.
We found some opportunities in Europe and emerging markets which were attractive. But the pandemic and recovery was unpredictable and different regions had varying levels of success in containing and navigating the challenges. You’re never going to get every call right. But if you can make a number of smaller, good decisions, you can meaningfully add alpha and help to mitigate risk across the portfolio.
All of this brings us full cycle.
All of this brings us full cycle. Back to tight spreads – in fact we’ve set new post-financial crisis tights in some sectors – and lower all-in yields. We are relatively constructive on growth and we see a supportive environment for credit, but the compensation investors are getting for bearing credit risk is low.
Our process of looking over a shorter time horizon and using multiple levers enabled us to navigate these very different environments.
Our process of looking over a shorter time horizon and using multiple levers enabled us to navigate these very different environments. This illustrates the last key to our process: an unbiased approach. We don’t have a process that we hope will work in strong credit markets only. Or in periods when rates are falling or rising. We work to manage our portfolios with an unbiased approach in order to build the best risk-adjusted portfolios we can with what the market is offering. We believe this process results in strong, foundational portfolios which can deliver throughout the cycle.
