#WellSaid

The Wellington Blog — A diverse marketplace of ideas, where our investment professionals share and challenge each other’s views. They decide independently how to draw on those ideas to sharpen their investment decisions, unconstrained by any single “house view.”

As we begin 2022, the weakness in the consumer technology sector continues. Two-thirds of internet stocks currently trade 30% lower than their 52-week highs, with many down more than 50%.1 Amid this sell-off, our conviction in the long-term outlook for tech in general and consumer tech in particular remains strong. The key question is whether this market presents an opportunity to buy the dip or if investors should remain patient as the pullback could persist.

In our 2022 Outlook, we noted that valuations, tough year-over-year comparisons, and decelerating growth are among the issues that make it difficult to have much conviction on this question. Adding the Omicron variant to the mix further complicates the outlook for the consumer technology sector.

However, we think technology’s long-term secular tailwinds signal that the recent sell-off could be a significant opportunity to…

MARKETS
THEMES
Brian Barbetta
Brian Barbetta
Global Industry Analyst
Boston

The 1970s were a memorable time for music, but many consumers and investors alike (at least those old enough to remember) might just as soon forget the economic “stagflation” — that toxic combination of flagging growth and soaring inflation — that plagued much of the decade. Forty-some years later, the specter of stagflation has resurfaced, as COVID-related supply-chain disruptions have persisted longer than expected and have converged with expansionary government policy (both monetary and fiscal) to push global inflation meaningfully higher in recent months.

As of this writing, the core Consumer Price Index (CPI) had reached levels well above its 20-year average range, even as GDP growth and many other leading economic indicators had weakened. Rising wages and energy prices have poured fuel on the fire, helping to create those unwelcome echoes of the 1970s — which, not surprisingly, were marked by generally poor real investment returns for…

For many asset owners, decarbonizing their investment portfolio has become a key policy objective supported by internal stakeholders. Debate persists, however, about how to most effectively do this. While exclusions may seem like the simplest solution, all divestment policies have tradeoffs.

1. Real-world impact is unclear

  • While fossil fuel exclusions can rapidly reduce a portfolio’s carbon footprint, their effect on real-world economic decarbonization takes much longer. High-emitting assets may continue to operate long after an asset owner exits a position. And, as more emissions-focused shareholders divest, company management teams may feel less pressure to decarbonize.
  • Emerging markets (EMs), which are significant fossil-fuel producers and consumers, typically have fewer transition resources. Limiting capital flows to EM-domiciled assets may…
SUSTAINABILITY
Erika Murphy
CFA, CAIA
Investment Director
Boston

2021 was, by all accounts, a good year for convertible bonds (“convertibles”). Despite bouts of volatility along the way, both US and global convertibles posted positive total returns last year, comfortably outpacing many other fixed income market sectors — including sovereign government bonds, as well as high-yield and investment-grade corporates.

Looking forward, we believe convertibles may continue to prove resilient, potentially benefiting from their distinctive structure amid the anticipated inflationary and rising-rate environment of 2022. Here are those three predictions for the year ahead.

Prediction 1: Convertibles to outperform both investment-grade and high-yield bonds

Since 1998, convertibles have outperformed both the Bloomberg US Aggregate Bond Index and the Bloomberg US Corporate Index in every period when interest rates rose by…

MARKETS
Dunkelberger, Raina
Raina Dunkelberger
CFA
Investment Specialist
Boston
Barry, Michael
Michael Barry
Fixed Income Portfolio Manager
Boston

Barring unforeseen macro or market developments, we believe the bank loan asset class looks poised to deliver positive total returns in 2022. Here’s why:

Inflationary pressures have raised the risk of tighter monetary policy

As we move into 2022, inflation risks remain paramount from an investment standpoint. We expect many investors to grapple with the potentially adverse effects on their portfolios, particularly as ongoing repercussions from the COVID-19 pandemic continue to exacerbate labor shortages and supply chain disruptions worldwide. Broadly speaking, we think mounting inflationary pressures have ratcheted up the risk of tighter monetary policy on the part of the US Federal Reserve (Fed) and…

MARKETS
Jeffrey Heuer
Jeff Heuer
CFA
Fixed Income Portfolio Manager
Boston
Dave Marshak headshot
David Marshak
Fixed Income Portfolio Manager
Boston
Nick Leichtman
Nick Leichtman
CFA
Investment Specialist
Boston

The past several months have seen a flurry of activity in the official sector1 regarding US Treasuries, as policymakers and stakeholders attempt to explain the startling dislocations that hit the Treasury market — generally considered to be the world’s deepest, most liquid securities market — in March 2020.

Indeed, it was only through swift, aggressive intervention by the US Federal Reserve (Fed) that said market dislocations did not become even more pronounced. It marked the second time in just a few years that the central bank had to intervene in the Treasury market to restore and encourage orderly operations — the other time being the Fed’s purchase of T-bills in the fall of 2019, which was designed to stabilize the short-term interest-rate market.

Understanding what happened in March 2020

So what led to the Treasury market dislocations and illiquidity back in March 2020? At a high level, the prevailing narrative is that…

MACRO
MARKETS
Amar Reganti
Amar Reganti
Investment Director
Boston

Climate change will continue to be an increasingly dominant theme as global climate-related regulation accelerates, disclosures such as the CDP (formerly the Carbon Disclosure Project) and the Task Force on Climate-related Financial Disclosures become more standardized (and in some regions, mandatory), and investor focus on the climate intensifies. In this short piece, we highlight how this impacts private companies and share our top questions for companies to be prepared to address as this issue grows.

Rising climate risks and investor expectations

In our view, companies across all sectors and stages should incorporate thoughtful approaches to climate change into their business models. This includes building resilience for the accelerating transition to a low-carbon economy and the worsening physical events exacerbated by climate change. Many companies overlook and/or underreport climate-related risks and opportunities that can be…

MARKETS
SUSTAINABILITY
THEMES
Hillary Flynn
Hillary Flynn
Director of ESG, Private Investments
Julie Delongchamp
Julie Delongchamp
CFA
Climate Transition Risk Analyst
London

As foreshadowed by US Federal Reserve (Fed) Chair Jerome Powell in his recent congressional testimony, as well as by other Fed officials, the Federal Open Market Committee (FOMC) yesterday accelerated the timeline for tapering its large-scale asset purchase program. The Fed’s monthly purchases of US Treasuries and agency mortgage-backed securities (MBS) will decline at a faster pace over the next few months, before coming to an end in March 2022. The culprit: rising inflation.

US inflation has been running persistently higher than both the Fed’s forecasts and its target range and has shown signs of broadening out across more goods and services. In response, the FOMC increased its inflation forecasts while also decreasing its growth outlook, as labor shortages and supply-chain bottlenecks have created greater inflationary pressures than the FOMC previously anticipated. The mounting inflationary risks also led the median FOMC participant to now expect the FOMC to hike interest rates three times in 2022 and three times in 2023. The US Treasury yield curve flattened following the release of the FOMC’s revised summary of economic projections, as the front end of the curve moved higher.

When will the Fed start reducing its balance sheet?

While not an imminent risk, market participants will eventually turn their attention to the timing of the Fed’s upcoming…

MACRO
Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

Investor enthusiasm for Japanese equities has long been dampened by the downward trend in the market during the 1990s and 2000s, as well as by structural challenges ranging from deflation to weak corporate governance. But we think this is an opportune time to consider a Japanese equity allocation, as we see seven potential positives that seem underappreciated by the market:

  1. Macroeconomics — recovering from COVID: While we’ll have to keep an eye on the Omicron variant, higher-frequency data suggests the economy has been regaining momentum since the Delta-variant-induced “state of emergency” status was lifted at the end of September. While an economic-surprise indicator for the country is currently very low, we think it has likely troughed.
  2. Monetary policy — benefiting from global inflation: While many developed market countries are struggling with excessively high core inflation (particularly the US), Japan has some way to go before core inflation will require…
MARKETS
Daniel Cook
Daniel Cook
CFA
Investment Strategy Analyst
Steven Ye
Steven Ye
CFA
Investment Strategy Analyst
Singapore

In our early December quarterly strategy group meeting, we debated the outlook for the high-yield market in 2022 and what it means for portfolios. At present, we favor maintaining a slightly defensive risk positioning given tighter valuations. While the macroeconomic backdrop and corporate fundamentals generally remain positive, we see some points of concern emerging at the margin. We expect high-yield credit spreads to move sideways in a year that could see plenty of volatility given multiple tail risks. However, we believe the ability to dynamically adjust positioning in the event of a significant repricing of credit risk will be key in 2022.

Macro: positive, but less positive

We continue to observe “yellow flags” on inflation and are watching for signs that inflationary pressures could shift from transient to permanent, leading to faster-than-expected tightening. On the flipside, previous Federal Reserve (Fed) policy cycles suggest that the high-yield market tends to perform well during the early stages of hiking when rate increases are…

MARKETS
Barry, Michael
Michael Barry
Fixed Income Portfolio Manager
Boston
Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London

While the United Nations Climate Conference of the Parties (COP26) ended with mixed results, we believe the outcomes are more positive than the media has portrayed. The resulting Glasgow Climate Pact will serve as a framework for accelerating coordinated action to limit global warming and avoid the worst effects of climate change.

More ambitious top-line targets: The Parties agreed to limit global temperature rise to 1.5°C (below the original 2°C goal) and reduce emissions by 2030, rather than 2050.

Going beyond CO2: Focus has expanded to the reduction of methane, a much more powerful warming agent than carbon dioxide.

Phasing out coal: The Parties agreed that unabated coal must become a smaller percentage of the global energy mix sooner than previously agreed. For the first time at a COP event…

SUSTAINABILITY
Alan Hsu
Alan Hsu
Global Industry Analyst
Boston

As discussed in my recently published 2022 Fixed Income Outlook, co-authored by my colleague Jitu Naidu, we believe inflation and interest-rate risks look poised to supplant the global COVID-19 pandemic as the new “bogeymen” facing investors in 2022. The dual specter of persistently higher inflation and steadily rising rates has many allocators particularly worried about potential implications for their fixed income exposures. Accordingly, many are now seeking defensive portfolio strategies — so-called “hedges” — for the new year.

Possible inflation scenarios

Market pricing for longer-term US inflation was recently in the mid-2% range, based on the latest “breakeven” inflation rates. There are still ongoing debates as to likely inflation outcomes going forward, but most of the informed forecasts appear to…

MACRO
MARKETS
THEMES
Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore

The short answer, as discussed below, is probably not, but it’s a fast-moving narrative that warrants some level of concern (though not panic). Here’s what we know and don’t know at this point and my thoughts on some of the potential implications.

What we know

Omicron is a new variant of COVID-19 that was first identified in South Africa, where it’s now the dominant strain of the virus. As of this writing, it has already spread to (and within) a number of other countries and regions, including Botswana, Hong Kong, Europe, and Israel. According to initial reports, most of the cases seen so far are concentrated among younger patients, who tend to be either unvaccinated or not fully vaccinated. (For context, South Africa’s vaccination rate is approximately 25%.)

Our health care analysts tell me that the mRNA vaccine is best positioned to be modified to provide protection from new COVID variants. An Omicron-specific version of the mRNA vaccine could be available in as little as…

MACRO
MARKETS
Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

Over the past decade or so, there have been countless studies and articles on the inability of active portfolio management to reliably add value versus market benchmarks, even before accounting for fees. However, most of the research tends to focus on US markets, particularly US large-cap equities, and glosses over (or ignores altogether) the reality that there are other market categories where active managers have, in fact, had a great deal of success historically (and may continue to do so). The inefficient Japanese equity market is a prime example.

A good fishing pond

The proof is in the pudding, as shown in Figure 1: During 70% of rolling three-year time periods over the past 20 years (ended 31 December 2020), at least 60% of active Japan equity managers — in some years, substantially more than that — have outperformed their respective benchmarks. By contrast, and as expected, most US large-cap equity managers have struggled to consistently top their benchmarks, with 60% or more…

MARKETS
THEMES
Ueki Hideo
Hideo Ueki
CFA, CMA
Director of Investment Products and Strategies
Megan Kelly
Megan Kelly
CFA
Research Manager
Boston

video-iframe

Investing in the metaverse

The growing excitement for the metaverse is powered by its incredible potential applications and the tremendous value they could create. But importantly, the technology enabling this seemingly magical innovation is still in development. What some overlook is that the biggest bottleneck today is not software or imagination — but rather the necessary upgrades to the metaverse’s foundational hardware infrastructure. This could create massive investment opportunities…

MARKETS
THEMES
Yash Patodia
Yash Patodia
Global Industry Analyst

Many investors want to be more long-term oriented — and most should be, at least according to longstanding conventional wisdom. But as we found in a recent survey, there are numerous obstacles to consistently maintaining a long-term focus, with market volatility, manager performance, corporate board pressures, and potential career risk topping the list. After all, short-term bouts of underperformance are all but inevitable when pursuing a long-term investment approach (Figure 1).

With all that in mind, I recently tackled three related questions:

  1. What exactly does it mean to be a “long-term” investor?
  2. Are there advantages to being more long-term focused?
  3. How can you identify a truly long-term-oriented…
MARKETS
Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

The fixed income market dislocations triggered by the onset of the COVID-19 pandemic left active portfolio managers with extraordinary opportunities to generate alpha not seen since the 2008 global financial crisis. Accordingly, many are well ahead of their benchmarks since COVID: The percentage of active core bond-plus and global aggregate bond strategies besting their benchmarks has spiked sharply to over 80% and 90%, respectively.1 Many fixed income allocators have, of course, benefited mightily from this recent spurt of active manager outperformance.

On the surface, there doesn’t seem to be a problem here, right? However, a closer look at this “golden era” of excess returns reveals potential structural manager biases and stylistic tilts that most investors may not expect, or necessarily want, from their fixed income allocation. These risk factor leanings have enabled many active managers to…

MARKETS
Brendan Fludder
Brendan Fludder
CFA
Research Manager
Boston
Carlos Coutinho
Carlos Coutinho
CFA
Solutions Portfolio Manager
Boston
Noah Comen
Noah Comen
CFA
Investment Strategy Analyst
Boston

Every quarter, the Wisdom of Wellington team surveys around 100 of our Wellington colleagues across different investment disciplines and locations to get their views on what we see as the key macro questions of the day. The results can pinpoint where the firm’s views differ from the consensus and can also reveal important shifts in our collective thinking.

The latest survey shows that, while the risk of a US recession is still considered low by historical standards, the probability of stagflation has increased. In our previous survey, 50% of participants noted the risk of a significant upside surprise in US inflation, but that figure has now risen to 63% (Figure 1).

FIGURE 1

The probablity % of a significant US inflation surprise has increased
At the same time, our respondents thought the economic cycle was…

MACRO
Benjamin Cooper
Ben Cooper
CFA
Multi-Asset Strategist
London
Juhi Dhawan headshot
Juhi Dhawan
PhD
Macro Strategist
Boston

The US Federal Reserve’s (Fed’s) message on inflation has changed. Fed Chair Jerome Powell recently characterized supply shocks, bottlenecks, and disruptions as “frustrating” and as “holding up inflation longer than we had thought.” The Fed’s mea culpa is small consolation for investors whose portfolios have not been positioned optimally for a longer-than-expected period of higher inflation.

The question now is: Has inflation already peaked? The short answer is no, in my opinion.

The systemic nature of supply shocks

Inflation is being pushed higher by three catalysts — labor, raw materials, and transportation — that are interrelated in ways that…

MACRO
THEMES
Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston
  • 40% of the world lives within 100 km of a coast.1
  • 110 million people live below high tide level; by 2100, that number will be 190 million.

Sea-level rise (SLR) is the climate risk that perhaps most captures the imagination. Pop culture has long depicted doomsday scenarios of ocean inundation and, increasingly, real-life disasters like 2012’s Hurricane Sandy and chronic flooding in coastal cities from Bangkok to Miami have turned fiction into reality.

Rising sea levels: Flooded New Jersey roller coaster

Coastal regions face risks of sea-level change

Thankfully, climate models show most catastrophic impacts of SLR to be far off, relevant for the end of this century and beyond. However, given the extreme risks that even minor changes in SLR pose, we expect spending on adaptation to…

SUSTAINABILITY
Xie Jenny
Jenny Xie
Climate Physical Risk Analyst
Boston

In my October blog post, A firsthand look at Brazil’s straitjacket, I painted a rather grim portrait of Brazil’s macroeconomic landscape following my latest visit to South America’s most populous nation. The “straitjacket” metaphor arose from my sense that Brazil may be increasingly hemmed in by its elevated rates of inflation — the heaviest “tax” on the poor — along with political uncertainty leading up to its October 2022 presidential election and a host of other country-level challenges.

I still believe that. But despite my downbeat macro outlook, as an emerging markets equity investor, I think there is a decidedly more positive side to Brazil’s story. After meeting with 22 of the country’s corporate CEOs, some of whom chatted with me for more than an hour, I came away more convinced than ever that Brazil offers plenty of stock- and industry-specific investment opportunities. You just have to…

MARKETS
THEMES
Jamie Rice
Jamie Rice
CFA
Equity Portfolio Manager
Boston

Most people who visit Japan for the first time come back raving about just how “clean” it is compared to other countries – which, in my view, makes it somewhat ironic that Japan has never really been considered a fertile hunting ground for investors looking for “clean” (environmentally-friendly) companies. But that doesn’t mean that such companies don’t exist here. On the contrary, we have found (and continue to find) great numbers of them; it simply takes some time and effort to identify and properly understand them.

A multitude of factors go into that search and vetting process, but as an investment team focused primarily on smaller companies operating in niche markets internationally, we see Japan as a land of hidden environmental, social, and governance (ESG) gems.

Lingering assumptions about Japan

At both the government and corporate levels, many observers have characterized Japan as a country that is slow to change and adapt to the times. That perception rings true to some degree with regard to ESG, particularly on the…

MARKETS
SUSTAINABILITY
Penn Bowers
Penn Bowers
CFA
Equity Research Analyst
Tokyo

Today’s record gas prices in Europe and Asia come with wide-ranging ramifications that investors need to be aware of.

Natural gas has been cheap for so long that investors and policymakers may have underestimated its pivotal role in modern-day economies. Now a combination of factors is driving steep increases in European and Asian power prices with the real possibility of shortages. Looking beyond the immediate repercussions we see significant investment implications.

In the short run, high power prices could mean:

  • Switching from gas to oil — Typically, only developing countries use oil for power generation as oil is easier to access and transport, but if shortages were to occur, Europe and East Asia could…
MACRO
MARKETS
Eugene Khmelnik
Eugene Khmelnik
Global Industry Analyst
London

For many fixed income investors, we believe high-quality securitized assets can play a valuable role in a diversified credit portfolio — and they have become even more attractive thanks to new risk-based capital (RBC) factors being adopted by the National Association of Insurance Commissioners (NAIC).

Should non-insurance entities care about these changes? We think so because the changes could impact credit spreads and investor demand across the securitized sector. For instance, we may see greater demand for AAAs/AA rated bonds and less demand for As, which could affect…

MARKETS
Alyssa Irving
Alyssa Irving
Fixed Income Portfolio Manager
Boston
Tim Antonelli
Tim Antonelli
CFA, FRM, SCR
Multi-Asset Strategist
Boston
Klimas Celene
Celene Klimas
CFA
Investment Specialist
Boston

With a sustained rise in interest rates in the coming months a distinct possibility as of this writing, we thought now would be an opportune time to take a close look at some potential impacts of higher rates on clients’ fixed income portfolios. To do so, we compared the hypothetical five-year performance of the Bloomberg US Aggregate Bond Index under three different illustrative scenarios that could play out going forward: 1) rates remain unchanged; 2) rates rise abruptly; and 3) rates rise gradually (i.e., over three years).

Key takeaways for fixed income investors

A few of our main takeaways from this analysis were as follows:

  • While abrupt rises in rates might lead to short-term drawdowns in fixed income portfolios, they can at times be desirable for longer-term investors, given opportunities to…
MACRO
MARKETS
Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore
Load More