Here, I’ll share what we’ve been hearing from these portfolio managers, as well as the strategies Commonwealth’s Investment Management and Research team takes as we navigate through uncertain times for the markets and economy.
The past few years have been a wild ride. 2020 brought a global pandemic that shut down the world economy, along with efforts by central banks across the globe to help consumers make it through those unprecedented times. 2021 saw the slow reopening of economies and burgeoning signs of inflation. In 2022, inflation moved to the forefront of concerns, and with it came a very aggressive Fed. Finally, 2023 forged a path that seemed to be leading toward a return to “normal”—although what that means continues to be debated.
Through it all, our team has advocated for balance and diversification across portfolios to navigate the unknown.
Our team also spends a fair amount of time talking to portfolio managers across equity styles, market caps, and geographies, as well as across different fixed income credit and duration profiles. We always ask, what are you doing to preserve and grow your clients’ assets through these challenging and rapidly changing times?
We’ve found that the answer to this question depends on which asset class the portfolio manager specializes in. The one constant we do hear, whether one is an equity or fixed income investor, is that the direction of interest rates has been a key determinant of returns during the past few years.
Given this, as rates stabilize, it may broaden the opportunity set and allow for decision-making that’s based on fundamentals and valuations. This is an environment that excites active investors, as it may provide them with the opportunity to add value above the return of a broad-based market index.
This result is exactly what we saw during November and December, as the equal-weighted S&P 500 Index outperformed the market cap-weighted S&P 500 Index. In anticipation of this backdrop, value investors have spent a fair amount of time scrubbing debt portfolios to understand the health of a company’s balance sheet before leaning into the more cyclical areas of the economy (e.g., housing-related stocks and financials). To value investors, these areas of the market look cheap.
Looking through a vastly different lens, growth investors continue to support the opportunity for artificial intelligence. They are focused on identifying winners and opportunities that have yet to be discovered by the broad market. Another theme getting their attention is the weight-loss drug market opportunity set. Growth investors believe both areas could achieve solid year-over-year growth without the help of a strong economy.
For fixed income investors, the opportunity set breaks down to government bonds and the rest of the market, which is composed of credit spread sectors. Government bond yields have risen considerably over the past couple of years, even after the recent drop into year-end. These new levels of yield could allow government bonds to be the diversifier that investors have come to know. This has led to an opportunistic increase in the durations within manager portfolios.
The rest of the fixed income market also may offer opportunities, as absolute yields certainly appear attractive. Still, investors must ask how much that higher yield is compensating for the increased risk. And the answer to this is dependent on how low in the credit quality spectrum the portfolio manager is investing in.
The good news as we enter 2024 is that a quieter year in interest rates should lead to more opportunities for investors to add value and give more breadth to the market than we have seen recently, in our view. But it, too, will come with its own set of uncertainties for portfolio managers as they chart the course ahead. Still, they remain confident that after several years of volatility within markets, the opportunity set is broader today than in the recent past. And as we ring in a new year, balance and diversification remain a solid investment philosophy.
Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.
Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. This material is intended for informational purposes only and should not be construed as investment advice or a solicitation or recommendation to buy or sell any security or investment product. The views and opinions in this commentary are subject to change without notice. Talk to your financial advisor before making any investing decisions.
Cap weighted: Index composition weights are based on the market capitalizations of the index constituents.
Equal weighted: Index composition weights give the same importance to each one of the index constituents.
Credit spread sector: A fixed income sector that offers additional yield over a government bond.
Duration: A measurement of a bond’s interest rate risk that considers a bond’s maturity, yield, coupon, and call features. Generally, it tells investors how much a bond’s price might change if interest rates fluctuate.