The COVID-19 pandemic and its economic fallout made 2020 an eventful year for investors, to say the least. Steep market declines at the beginning of the year were followed by a swift recovery, spurred by government intervention and strong results from many growth companies. As countries around the world make progress against the pandemic, 2021 promises to deliver a new narrative for family offices.
As part of a recent webcast series in partnership with BDO United States, Brian Feurtado, Global Head of Family Offices, spoke with Alan McKenzie, Chief Investment Officer for Family Offices, about investment themes for the coming year and their implications for family offices. Following is a summary of their conversation.
What will the major trends for investors be in 2021?
COVID-19 will continue to be a major theme, both short-term and long-term. We're optimistic that as the vaccine rollout continues to gather steam, it will have a significant impact on markets and economies. Combine that with fiscal stimulus in the U.S., plus very accommodative central banks that are committed to limiting the rise of yields, and we're positioned for a pretty robust recovery in the second half of the year.
Between now and then, there may be some volatility. But in general, the market is looking beyond a lot of the short-term concerns about COVID toward a second half of the year that will provide a favorable environment for risk assets.
We're also seeing COVID accelerate some trends that we'd already begun to notice. For example, we see the U.S. continuing to have a more expansive relationship with China, and we see technology emerging as a long-term winner. In addition, we think the market has not effectively priced in a lot of risk associated with climate, and we're trying to get ahead of the curve on sustainability issues.
Given the low-rate environment, where can investors go for yield?
Historically, yield-oriented investments have been focused on fixed income. But yields on fixed income have been very low recently, whether we're talking about Treasuries or corporate bonds, and our view is that they're likely to remain low for the foreseeable future.
Fixed-income investments traditionally serve two main roles in portfolios: yield and diversification. When today's investors chase yields, they often move into asset classes that are less diversifying. The challenge is to find new sources of yield that also offer a measure of diversification.
Emerging markets present one opportunity, particularly in illiquid markets. For example, private credit in Asia offers very attractive yields along with diversification benefits. China bonds also provide a yield pickup and are somewhat diversifying.
What are some of the other big themes you're emphasizing in 2021 portfolios?
Sustainability is a major theme. Historically, sustainability hasn't been a primary concern in portfolio construction. We're moving it into the forefront of our thinking. Our work is grounded in the view that climate risk is an investment risk, and we're incorporating sustainability into forward-looking return expectations.
It's worth mentioning China again. We think China is significantly underrepresented in investment portfolios. China is responsible for between 15% and 18% of global GDP, but it represents only about 5% of global equity markets. So, there's a real disconnect between the economic impact of China and how it's accessed by investors.
We think investors are under-allocated in illiquid investments across the board. It's becoming more challenging to generate really high rates of return in public markets, so when we're constructing portfolios we're looking at illiquid investments as a primary growth driver. Private equity, private credit, and infrastructure, for example, all provide distinct opportunities for investors, and we're including them strategically in our clients' portfolios based on their particular return targets and risk tolerance.
We're also looking at certain factor exposures to make sure investors have exposure to a broad basket of securities that will participate in a robust economic rebound, which may mean focusing more on value or on a cyclical orientation.
What's your thinking about valuations in the coming year?
It depends on your metric, and it depends on the market you're talking about. For example, if we're talking about the S&P 500, that asset class looks richly valued across multiple metrics. Then again, if you look at it relative to the free cash flow that the companies are generating, and also relative to an opportunity set in which yields are so incredibly low, the valuations don't look as stretched.
Furthermore, if you look at the equity market you can identify particular parts that are not overly valued. That is why it's important to identify different themes and sectors that are attractive within equities. We're thinking about cyclical securities that we think will participate in a rebound but are not richly valued at this stage.
Brian Feurtado: Good morning, everybody. I’m Brian Feurtado, and I’m the Head of BlackRock’s Family Office Business here in the United States. And we want to welcome everybody and thank you for joining us for this first webcast in a series of conversations on Family Offices. This series was importantly created in great partnership with BDO. We are very appreciative of that partnership with them. The idea is that we provide expert insights that are tailored specifically for the Family Office Community to stay informed on priorities and trends that are top of mind in the high-net-worth space. And we’re excited to be joined here today by my colleague and friend Alan Mckenzie, who is the Chief Investment Officer for the Family Office Business in the United States for BlackRock. And with Alan over the course of the next 20 minutes, we’re going to discuss his outlook and the firm’s outlook on investment themes for the coming year and what this means with Family Offices. But before we jump into that with Alan, we just have a couple of programming details to go through. During the course of this session, we are going to have some live polling and you’ll be able to engage with us and see how your peers are responding. So, the polling questions and results will appear on the side of your screen. And also, importantly if you would like to see the 2021 BII Outlook, we will have that also in the event resources that you can take a look at. Alan’s going to speak to that obviously, but if you want to look along, you can do that also. So, with that let’s dive in here, excited to talk to Alan. Hi Alan, how are you?
Alan McKenzie: Good, Brian, yourself?
Brian Feurtado: Terrific, really, really good.
Alan McKenzie: Excellent.
Brian Feurtado: So, 2020 was a very boring year, nothing really happened. Just kidding. 2020, I mean what are the words we’ll use Alan? I mean extraordinary, right? I mean, unbelievable, unexpected. Yeah, so let’s start with the big picture. So, for 21, can you set the stage for us and for the audience, as you look at the year ahead and what’s top of mind for you as you look at the investment markets this year?
Alan McKenzie: Sure. So, I think we’re really focused on COVID-19 from a shorter-term and a longer-termed perspective. I think we’re clearly seeing some positive trends as it relates to the vaccine and we are quite optimistic that once the vaccine rollout gets up to full-steam, it will have a significant impact. And we combine that with fiscal stimulus in the U.S., very accommodative central banks who are effectively committed to limiting the rise of yields. We think we’re positioned for the second half of this year for what should be a pretty robust recovery. Now, getting there might be a little bit more volatile than we’re used to other than we are anticipating. But again, I think the market is looking through a lot of the short-term concerns around COVID spike and hospitalizations; difficulties with the vaccine rollout and really looking through a lot of that. So, I think on a shorter to intermediate-term basis, we are looking towards the second half of this year as being quite a favorable environment for risk assets. The other thing I think we’re seeing is that what COVID has done is really solidify or accelerate a lot of trends that we had already noticed but have really become -- again, more emphasized as the function of COVID-19. So, you know, whether that’s continuing to have a more expansive relationship with China. Whether it’s looking at particular sectors like technology that we think are kind of longer-term secular winners or potentially looking at things like sustainability. Where we think the market has not effectively priced in a lot of risk associated with climate and kind of trying to be a little bit ahead of that curve, as we think about what’s the right way to price that risk in your portfolio?
Brian Feurtado: That’s helpful Alan. Really interesting insights there on COVID and where we’re going to go and that thing, the really big focus for obvious reasons. One of the things you mentioned was yield, that’s obviously one of the questions we get the most from clients. And given the low-rate environment, where can clients go for yield now?
Alan McKenzie: Yeah. So, I think it’s -- when we think about yield-oriented investments which historically might have been focused exclusively on fixed income, right? We’re really thinking of them serving two roles in a portfolio; one is diversification; and one is yield. Historically, you were able to get a combination of both of those whether through treasuries and yields were higher than they were now, on corporate bonds with yields being solo. And again, our view is that they’re likely to remain low for this foreseeable future. What we’ve had is investors look to chase yields for lack of a better term. And as they chase yield, they end up moving into asset classes that are less diversifying. So, you kind of had this offset of as I seek yield, I am lowering the diversification benefit of my yield-oriented portfolio. So that I think is the real challenge. So, it leads people to do a couple of things. One, we do think there is -- still attract evaluation and things like high-yields globally. And so that is an area we would continue to allocate assets to. Emerging markets is another one but other areas, I think are really becoming more important to us because while both of those offer yield, they don’t necessarily offer much in the way of diversification. So, as we look and continue to look outside the U.S., we want to look at not only liquid markets, but illiquid markets. So, I’ve talked a little bit about China and we think that there’s going to be -- China’s going to continue to be a focus of global markets. Things like private credit in Asia, where you’re able to get very attractive yields. There’s a newer market, disintermediation. The opportunity set is very robust, provides diversification benefits and yield; even China bonds provide a yield pickup and are somewhat diversifying. So, I think it’s really trying to think about, I want to reach for yield but I really want to be very conscious of maintaining an overall level of diversification and trying to identify those opportunities whether it’s China bonds, Asian private credit, whatever it may be that kind of offer me the ability to do both of those successfully.
Brian Feurtado: Make sense, diversification is the key if you’re looking -- and so bringing in the international side, the offshore Asia, really, really interesting, thanks Alan. Let’s pivot to a topic that is very top of mind right now for a lot of our clients, which is sustainability and ESG. Can you talk to us about that? It’s something that a lot of our clients are asking about. Obviously, our CEO and Chairman, Larry Fink has been talking a lot about that here in the last couple of days. What’s your view as we think about building those themes into client portfolios?
Alan McKenzie: So, we obviously are doing a lot of work in that regard and I think it’s grounded in the view that the climate risk is investment risk. And so, the idea is “How do we quantify that when we’re thinking about portfolio construction and building portfolios?” So, we have been doing a lot of work on thinking about our forward-looking return expectations. As we’re building portfolios, we’re generating these forward-looking return assumptions. What we’re now doing is incorporating sustainability into those forward-looking return assumptions. So, effectively trying to look forward and price in the investment risk that is associated with climate change in particular. So, I think it’s trying to move it into the forefront of thinking about portfolio construction and building a portfolio; as opposed to historically, where it’s been kind of the second or third thing that comes across. Let me build the asset allocation. Let me think about risk and then I’ll think about implementation with vehicles that might have a positive impact. Now, I think what we’re arguing for is moving that forward more into actually thinking about as I’m building my portfolios, I’m constructing my portfolio. How do I think about building sustainability into that portfolio? And how do I think about recognizing the fact that it is an investment risk that may or may not be effectively priced into different asset classes.
Brian Feurtado: Yeah, definitely. An investment risk that we have to really take account of now and something that’s really big and forefront. Speaking of that, what are some of the other big themes that you’re thinking about for portfolios now? Whether it’s -- geographies that you think that emphasizing or different parts of the market.
Alan McKenzie: Yeah.
Brian Feurtado: -- quite a lot of movement and a lot of interesting innovation and a lot going on. What else --
Alan McKenzie: Yeah, I would say again and I think some of this is related to some of the trends that we saw pre-COVID but have just been kind of more focused as we’ve gone through the pandemic. And I would break it down in a couple of areas. One, we are definitely identifying that there are particular sectors that are likely to come out of COVID in a very favorable position. So, we talked a little bit about technology. We do think there’s a longer-term secular trend towards technology where these companies would likely be able to generate really attractive or earnings growth. And so, things like making sure we’re exposed to those types of rapid growing companies is a trend that we see continuing over the next 12 to 18, to 24 months. I think the other area that I think is interesting is I talked a little bit about China. We think China is significantly underrepresented in investment portfolios. Certainly, across the marketplace in the U.S. So, if I think about China as a part of the global economy, it’s depending on which metric you use, it’s anywhere between 15 to 18% of global GDP, but it only represents about 5% of global equity markets. So, you’re getting a real disconnect between the economic impact of China and how its accessed by investors. So, we do think and continue to think that especially in light of the current environment, where we’re likely to have more of a favorable relationship with China, trade policy would likely be less of a contentious issue. We think that that’s another area that we would continue to be really interested in. And then lastly, I think as we think about positioning for the second half of 2021, given our view on a pretty robust economic rebound, we would look to within certain factor exposures, think about making sure that we’ve got exposure to a broad basket of securities; that will participate very nicely in that recovery. So, whether that’s focusing a little bit more on value or on cyclical orientation. That that I think is a theme that we’d likely see play out in the second half of the year. Just given all the policy response that the fiscal and monetary stimulus. And again, what are seeing in the data is the foundations of a very strong recovery that we think will simply accelerate once we get through this COVID vaccination question mark.
Brian Feurtado: Makes sense. And to that point, anywhere else you think is -- that jumps out when our clients are under-allocated?
Alan McKenzie: Yeah, I think the problem -- I mean, illiquids in general, I think across the Board, we would argue clients are probably under-allocated, perhaps not historically if this makes sense, but relative to the opportunity set going forward. So, getting back to your earlier question on yields and opportunities set in terms of return. I think if you look at the opportunity set, one of the things that you’ll hear from BlackRock is it’s becoming more challenging in public markets to generate really high rates of return, right? It’s becoming more of a challenge in public markets to do that. So, we continue to look and when we’re constructing portfolios, we continue to look at illiquid opportunity set and think that the investors are being really handsomely compensated for taking that illiquidity risk and we would continue to argue that going forward, investors should continue to look to that space as a primary growth driver within their portfolio.
Brian Feurtado: Right, and so let’s dive in on that a little bit. So, as you think about the illiquids, how do you think about structuring those portfolios? There’s so many different directions you can go in with private equity broadly. Like how do you build out a portfolio like that?
Alan McKenzie: So, we tend to think of it in different buildings blocks. So, we’ll break down private markets into a number of different subcategories and we think they all have potentially different risk-reward characteristics. And so, the beauty of the way we think about building portfolios is we don’t tend to think about private markets as an asset class, if that makes sense. We tend to think about all of the asset classes underneath that as asset classes. So private equity versus private credit, versus infrastructure, they’re all different; they have very different characteristics. So, when we’re thinking about building a portfolio for a client -- again, we’re thinking about what is it that the client is trying to achieve? What is the actual return target and based on that information, as well as risk tolerance, we can really get quite creative in term of thinking about what the composition of a portfolio would look like and that could be quite granular; so, for example, even within private equity, we can think about “Well, how much do I want to have in direct or co-investment opportunities which offer me a higher alpha potential? Than investments in private equity funds that might not offer me the same alpha potential but are kind of private equity beta if you will.”
And then how do we think about things like secondaries, other opportunities that are somewhere in between those two in terms of risk reward? So, I think it’s all about understanding what the private opportunity is and thinking about how do I think about that fitting into my broader portfolio?
Brian Feurtado: Makes sense. And here’s another question for you Alan to think about. It’s going from the illiquids now back to the liquid markets. Something that comes up a lot with our clients is just with the valuations, I guess. The valuation question and yeah, liquidity events, people have -- there would be cash that they haven’t put to work in the market yet and looking at these valuations here thinking sort of short-term, long-term. How do you think about staging money into the market or how do you think about these valuations in general right now?
Alan McKenzie: So, I’ll answer that in a couple ways. One, it depends on your metric and also, it depends on the market you’re talking about. So, if we’re talking about the S&P 500 for example, I think on multiple metrics, that particular asset class, that particular investment looks richly valued. But then again, I think if you look at it relative to things like free cash flow that the companies are generating, also relative to the opportunity set, which is where yields are so incredibly low; valuations don’t look as stretched. Furthermore, I think if you look within the equity market and can identify -- again, I talked a little bit about cyclicals, you can identify particular parts of the market that are not overly valued that do offer a tracked evaluation, which is again why I say when we’re thinking about investing specifically in equities, we want to be thinking about these different themes, these different sectors that we think are positioned well, that are attractive. But also, thinking about cyclical securities that we think will participate in a rebound but are not richly valued at the stage of the market.
Brian Feurtado: Makes sense. One last question before we wrap up here Alan. Obviously, for all of us that are in here in the U.S., we have to think about taxes. We’ve had a change in administration, it’s just broader -- about taxes and tax policy and then just changes in the future here.
Alan McKenzie: Yeah. So obviously, one of the concerns about the election result, was that there would potentially be more regulation and higher taxes with the new administration. Because that was part of the platform and as we kind of surveyed the landscape and do our research down in D.C., I think there is a prevailing feeling that tax increases are not a priority for the administration for the foreseeable future. The focus is going to be on stimulus, the focus is going to be on getting through this economic crisis, at which point in time the administration may look towards potentially changing the tax code. But again, we’re not seeing that is something that is an immediate priority for the administration for the foreseeable future.
Brian Feurtado: Makes sense. Well, I think we are getting up on time here Alan. So, thank you. We really appreciate your insights here, we appreciate the partnership with the BDO and we’re looking forward to doing more of these. This is just the beginning of a series and we would love to have feedback from the audience. So please, send in feedback in some of the survey that you’ll see. And we look forward to doing this again in the future and Alan once again, thank you so much for doing this.
Alan McKenzie: No. No, my pleasure. Thanks Brian.
Brian Feurtado: Cheer everybody. Bye-bye.
Watch the full conversation on-demand
Brian Feurtado and Alan McKenzie discuss investment themes driving markets in 2021, tactical asset allocation ideas and where they see opportunities for family office investors.
