Generating returns in today’s market

• We’re trying to generate above-average, risk-adjusted returns through a full market cycle. The era of central bank activism has created very short minicycles but also much longer economic and full credit cycles. 

• To generate returns, you must be cognizant of the economy and the underlying fundamentals of the companies that you want to own through a cycle. This makes sense because your upside is your coupon, and your downside is default. 
• Investors can seek to amplify those returns over time by taking advantage of behavioral inefficiencies in the market—for example, by providing liquidity when a particular security or sector of the market is under stress. We believe it’s important to have core positioning around good-quality companies that are going to potentially reward investors over time and that investors feel comfortable holding through bouts of volatility.
• Ultimately, the market’s short-term focus offers long-term investors a time horizon arbitrage, which we feel is a very persistent source of alpha. For example, despite fairly extreme central bank activism and backstops for credit post-COVID, we maintained a relatively low risk profile, not wanting to be exposed to late-cycle credit with rich valuations that likely have greater downside than upside if the market stumbles. We feel that managers who outperform in the short term are taking risks that they’re not being well-compensated for. In our view, that’s never a good long-term strategy. 
• As bondholders, investors are lending money to companies, and they need to understand how willing and able the companies are to pay investors back. If investors don’t have a deep understanding of fundamentals, they’re gambling, and that’s not an investment strategy.

A shifting landscape

• We’ve had a generation of declining interest rates and a half-generation of central banks fighting deflation. This has made it relatively easy to outperform over the past 30 to 40 years. 
• More recently, we’ve seen bailouts and backstopped credit markets as policymakers have sought to prevent investor losses. The future will likely be different. 
• There’s a shift underway from capital to labor. The focus ahead will be less on central bank liquidity and more on wages, organic growth and consumption. Against that backdrop, if we don’t need capital markets to fuel people’s portfolios as much, maybe the Federal Reserve will step back and protect investors less proactively. 
• Over the next few years, what investors don’t own will be more important than what they do. Overleveraged balance sheets, declining margins and rising labor and energy prices are going to be major headwinds for companies that are not prepared.

Tailwinds turning to headwinds

• For decades, globalization has restrained wages. But that appears to be over now. 
• The cost of capital is rising. We have to deal with retooling and reshoring. Businesses will probably need more working capital to invest in productive capacity after years of focusing on financial engineering. It’s going to take time and be expensive. If the demand for capital exceeds the savings rate, we’re looking at higher interest rates, a higher cost of capital and potentially wider credit spreads. 
• We think investors will need a good partner to avoid these landmines.

Portfolio positioning: Plenty of levers left to pull

• Broadly speaking, we’re positioned to the lower-risk side. We have room to add high-yield or emerging market exposure, or go down in credit. There are plenty of levers to pull. 
• We’re a big fan of providing liquidity in sectors and names we like when we’re paid to, and think the banking sector may be one. 
• One long-term trend we’re looking at is electric vehicles. While we might not own the bonds of EV manufacturers, we can look for exposure via suppliers to the industry. For instance, aluminum component manufacturers are benefiting from vehicle light-weighting. It gives us exposure to materials with a very secular and relatively low capital-cost tailwind. 

Sponsored by