Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
‘A narrow path forward’ between value and growth
The ongoing market dislocation has opened another chapter in the blood feud between value and growth managers, with growth managers retreating to lick their wounds while value managers ride triumphant once more. But a peek under the hood of the global economy reveals bad news for value and growth, and the way forward borrows a bit from both, according to Talaria Capital co-CIO Chad Padowitz.
“If I had to choose value or growth (I’d choose value) – but we think there’s another way,”
Padowitz said. “Healthcare isn’t necessarily value; generally value is financials and energy and industrials because they’re most linked to the economy and have a tremendous amount of operating and financial leverage. Slight increases in the economy and their profit explodes higher and you can do very well.”
“But we think the economy is going to be quite challenging. We think you have to find a very narrow pathway that doesn’t have so much of the economy where value does well, but doesn’t have the valuation issue where the growth names still are. You find that very narrow pathway through healthcare, through insurance, but also lower beta and lower duration. You need a very different toolset.”
Calling the bottom is usually a fool’s game, but Talaria holds that there are two indicators that have, since 1950, established when markets will bottom: when leading economic indicators like the ISM Manufacturing Index trough, allowing investors to anticipate a recovery; and, more obviously, when central banks return once more to policy supportive of markets. Both events are so far off in the distance that investors must squint to see them. It’s a grim message, one that analyst Max Welby calls more “Francis Bacon than Leonardo De Vinci.”
“That doesn’t mean you can’t get very sharp recoveries in the market,” Welby said. “If you look at bear markets over time, bear market rallies are the norm, not the oddity. But that supplies you with an opportunity to do something; it doesn’t change the overall view.”
For the last decade, there’s only been two games in town, Welby says: US stocks and US tech, with investors conditioned to buy the dip in both by an even longer period of low rates. So certain breeds of investor will be heartened to hear that financial markets will once more move in line with the real economy, even if there’s still a lot of pain on the way. But while Talaria has been window-shopping, prices aren’t yet low enough to justify jumping into the dislocation.
“Yes, the market has dropped – but when you look at the individual stocks, there was a lot more value on offer in the February-March period during Covid,” Padowitz said. “We don’t think it’s tremendously attractive. The mistake you can make when prices drop is assuming that there must be great opportunities.”
