Our current point of view on the Q3 2020 markets, which we share with clients, peers and the industry
“This roadmap informs our portfolio design. As markets shift, we reflect and adjust.”
— Alex Bass, Chief Investment Officer
Tax-exempt bonds serve the purpose of providing capital stability and the tax-free income continues to be valuable, particularly for those investors in high-tax states. Strong demand coupled with decreased supply dynamics and overall lower interest rates has favored the group. However, forward return potential is muted given the historically low rate environment and credit quality concerns could increase as a result of municipal finances being pressured by the COVID-19 health crisis.
While some pockets of the bond market still offer excess spread, the risk/return dynamic in broad bond indices, particularly for taxable investors, remains unattractive – yields remain low and duration is elevated. We are especially avoiding corporate high yield bonds, where spreads have compressed below average levels and will offer no protection if credit quality deteriorates.
US Large Cap
Given the strong rebound in the US equity market since March, we are more neutral at this higher valuation level against the background of a still uncertain economic recovery. Strong support from the federal government and the Fed continue to be tailwinds, however we believe that is discounted in current market levels. We would look for a more attractive entry point to increase exposure, possibly as volatility picks up closer to the November election.
US Small / Mid Cap
Small/mid cap companies have lagged in the recent market rebound, however higher leverage levels and lower profitability lead us to maintain a neutral view on this group at this time. We favor an active management approach in this market segment and look to increase our allocation in a market pullback.
Developed international markets are trading at a more attractive valuation relative to the US and their historic averages. We believe a weaker US dollar, the prior meaningful underperformance, and more effective COVID-19 response will be supportive of international developed markets as the underperformance to the US markets narrows.
The underperformance of Emerging Markets over the past decade has made valuations more attractive, considering that earnings growth has sustained. A weaker US dollar and strong underlying demographic trends should benefit performance. Given the volatility in the asset class, we still want to size the allocation to the emerging markets appropriately.
Alternative Investments encompass a wide range of strategies. Our focus remains on identifying those which can benefit the portfolio through diversification (healthcare royalties), increased cash flows (alternative lending; real estate), or by taking on idiosyncratic risks (growth equity). Additionally, real assets such as gold and silver can benefit from a weaker US dollar.