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Webinar Replay | Solving for 2022
As 2021 draws to a close, the leaders of our investment platforms gathered to talk about the evolution of the investment environment and the key themes they anticipate for 2022. Watch Now
Ten for 2022
The heads of our investment platforms identified the key themes they anticipate will guide investment decisions in 2022.
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Perspectives from Our Investment Leaders
Erik Knutzen on Macro
Brad Tank on Fixed Income
Joseph Amato on Equities
Anthony Tutrone on Alternatives

Macro: Entering a New Age

The Start of Another Long Cycle—But Also a More Volatile One?
The Start of Another Long Cycle—But Also a More Volatile One?
We are moving from the recovery phase of the current cycle to its middle phase. But what kind of cycle is it likely to be? The previous cycle was the longest in history and it ended only due to the exogenous shock of the pandemic. If anything, we believe that the willingness of fiscal and monetary authorities to support the cycle is even greater today. Inflation and new redundancies built into supply chains could introduce more business-cycle and market volatility, but we think we could be in for another long expansion.
Inflation: Higher and More Problematic
Inflation: Higher and More Problematic
After 40 years of declining inflation and interest rates, the direction of travel appears to be changing, due to new central bank policy priorities, China’s strategic reorientation, the energy transition, pressures in supply chains and labor’s increasing bargaining power in negotiations over the spoils of growth. The tilt toward supply-side, cost-push inflation in this dynamic will likely pose a challenge to central banks. How central banks choose to navigate a changing inflation environment will likely generate market volatility in the coming year.
A New Age of Politicized Economies—And Not Just in China
A New Age of Politicized Economies—And Not Just in China
China’s ongoing strategic reorientation of its economy explicitly elevates social and political objectives such as “common prosperity” and “internal circulation” over outright growth. But this is not just a China story. Worldwide, political and monetary authorities now have more tools, more capacity and more willingness to direct economic activity than ever before—in pursuit of climate, social equality, political, geopolitical and security goals, among many others. That likely means higher taxes. As the role of markets in resource allocation diminishes, we could also see more supply-and-demand mismatches, inflation and volatility.
Net-Zero Goes Mainstream
Net-Zero Goes Mainstream
The 26th United Nations Climate Change Conference of the Parties (COP26) wrapped up as our themes went to press. Many countries went into COP26 lagging in their commitments, but impetus appears to be growing. The European Union’s “Fit for 55” legislative agenda sets an aggressive standard. Just as important, the private sector is pressing ahead: we see critical mass in corporate net-zero pledges and plans, and in signatories to asset managers’ and asset owners’ net-zero initiatives. It will become increasingly imprudent in our view to ignore climate and climate policy risks in portfolios.

Fixed Income: Rates Adjust, Investors Embrace Flexibility

An Orderly Adjustment for Bond Yields and Spreads
An Orderly Adjustment for Bond Yields and Spreads
Core government bond yields remain low, particularly relative to current inflation; and credit spreads, in our opinion, are priced for perfection. We think the direction of travel in 2022 is up and wider, respectively. Finding income with modest or no duration will continue to be the priority, in our view, but major market disruption or significant credit issues appear unlikely. We believe a more tactical fixed income investment environment is developing.
Investors Pursue a More Flexible Approach to Seeking Income
Investors Pursue a More Flexible Approach to Seeking Income
Faced with a combination of low and rising rates and tight credit spreads, investors are likely to double down on their search for short duration, floating rate, and less correlated sources of income. They may complement this with more tactical positioning, whether that be in interest rate risk exposure, asset allocation or into narrower, niche, but attractive markets. The opportunities likely to draw attention range from short duration credit, loans and collateralized loan obligations (CLOs) to China bonds and European corporate hybrid securities. We believe a mix of these short-duration, less-correlated and tactical sources of income could pay dividends in the year ahead.

Equities: Reflationary Themes

A Reflation Tailwind for Value and Cyclical Stocks and Regions
A Reflation Tailwind for Value and Cyclical Stocks and Regions
We think inflationary expansion is likely to support cyclical over defensive sectors, value over growth stocks, smaller over larger companies and non-U.S. over U.S. markets. That pattern was interrupted after Treasury yields hit their peak in March 2021, but could reassert itself as yields start to edge up again—particularly if this is accompanied by a weaker U.S. dollar. This environment would normally bode well for emerging markets, but substantial headwinds mean we tend to favor only specific opportunities, such as leading companies in India’s innovation sectors.
With Stretched Market Valuations, Income Becomes More Important
With Stretched Market Valuations, Income Becomes More Important
The story of value underperformance is well known. But income, as a subset of value, has fared even worse over the past decade. There are three sources of equity returns: multiple expansion, earnings growth and compounded dividend income. Multiples appear stretched, and earnings have been growing above trend—which suggests to us that income may be more reliable over the coming year. Over the past 50 years, income has accounted for around 30% of equity total returns. Moreover, in an inflationary environment with low but rising rates, equity income is also a way to get short duration and inflation exposure into portfolios at relatively attractive valuations.

Alternatives: No Longer Alternative

A Bigger Menu of Non-Traditional Diversifiers for Investors
A Bigger Menu of Non-Traditional Diversifiers for Investors
Investors face high valuations in many growth markets, combined with rising yields and diminished diversification benefits from core bonds, and the potential for inflation running above recent trend levels. This appears likely to encourage all types of investor to make larger, more diverse allocations to alternatives, liquid and illiquid, as well as assets that can mitigate the impact of transitory and secular inflation, such as commodities and real estate. Individual investors may have the ability to make the most notable move, as private equity and debt products become more accessible to them.
Execution Risk, Not Market Risk, Will Likely Determine Success
Execution Risk, Not Market Risk, Will Likely Determine Success
Valuations are high in current private equity deals. However, while starting valuation can be a strong determinant of long-term public equity returns, the relationship has not been so strong in private markets. We think that could be especially true with today’s deals, from venture to buyout. Whereas historical vintages often relied on buying cheap and applying leverage, we see that today’s average deal is comprised of more than 50% equity, and depends for its potential returns on successful operational and strategic enhancements, and merger-and-acquisition (M&A) “roll-up” programs.
ROUNDTABLE DISCUSSION
Entering a New Age
As 2021 drew to a close, the leaders of our investment platforms gathered to talk about the evolution of the investment environment over the past 12 months and the key themes they anticipate for 2022.
Joseph V. Amato
President and Chief Investment Officer—Equities
Erik L. Knutzen, CFA, CAIA
Chief Investment Officer—Multi-Asset Class
Suzanne F. Peck
Head of Investments – Private Wealth Management
Joseph V. Amato, President and Chief Investment Officer—Equities

Joseph V. Amato serves as President of Neuberger Berman Group LLC and Chief Investment Officer of Equities. He is a member of the firm’s Board of Directors and its Audit Committee. His responsibilities also include overseeing the firm’s Fixed Income business. 

Previously, Joe served as Lehman Brothers’ Global Head of Asset Management and Head of its Neuberger Berman subsidiary, beginning in April 2006.  From 1996 through 2006, Joe held senior level positions within Lehman Brothers’ Capital Markets business, serving as Global Head of Equity Research for the majority of that time.  Joe joined Lehman Brothers in 1994 as Head of High Yield Research.  Prior to joining Lehman Brothers, Joe spent ten years at Kidder Peabody, ultimately as head of High Yield Research. 

He received his BS from Georgetown University and is a member of the University’s Board of Regents and the Business School’s Board of Advisors. He is also Co-Chair of the New York City Board of Advisors of Teach for America, a national non-profit organization focused on public education reform.

Erik L. Knutzen, CFA, CAIA, Chief Investment Officer—Multi-Asset Class
Erik Knutzen, CFA, CAIA and Managing Director, is Co-Head of the Neuberger Berman Quantitative and Multi-Asset Class investment team and Multi-Asset Class Chief Investment Officer. Erik joined in 2014 and is responsible for leading the management of multi-asset portfolios, driving the asset allocation process on a firm-wide level, as well as engaging with clients on strategic partnerships and multi-asset class and quantitative solutions. Previously, Erik was with NEPC, LLC where he served as chief investment officer since 2008. As CIO, he oversaw a group of more than 45 investment professionals, including dedicated research teams focused on Alternative Investments, Traditional Strategies and Asset Allocation for NEPC’s client base with, collectively, more than $800 billion in assets under advisement. He has over 25 years of experience in the financial services industry, including nine years at Putnam Investments. In 2013, he was recognized by aiCIO magazine, ranking atop their 25 most influential investment consultants. Erik holds an MBA from Harvard Business School and a BA from Williams College. He has been awarded the Chartered Financial Analyst designation, as well as the Chartered Alternative Investment Analyst designations. Erik sits on the Boards of the Massachusetts Audubon Society, where he is a member of their Investment Committee, and of Start Small Think Big.

Suzanne F. Peck, Head of Investments – Private Wealth Management
Suzanne F. Peck, Managing Director, is the Head of Investments for Private Wealth Management at Neuberger Berman, and a member of the firm’s Asset Allocation Committee. Prior to joining the firm in 2021, she was Head of BlackRock's Endowments and Foundations effort, which provides investment management services and risk advisory solutions to endowments and foundations, including outsourced CIO services. Prior to joining BlackRock in 2013, Suzanne spent 18 years with Goldman Sachs, most recently in its Investment Management Division, where she served in a number of roles including Portfolio Manager and member of the Investment Committee of Institutional Client Solutions. She also led a team that built an outsourced CIO offering for endowments and foundations. Previously, Suzanne spent nine years in the Investment Banking Division. Suzanne serves on the Investment Committees and Boards of UJA-Federation of NY and the New-York Historical Society. She earned a BA in history from Columbia College, MA in economics from New York University and MBA from Columbia Business School.
Brad Tank
Chief Investment Officer—Fixed Income
Anthony Tutrone
Global Head of Alternatives
Brad Tank, Chief Investment Officer—Fixed Income
Brad Tank, Managing Director, joined the firm in 2002 and is the Chief Investment Officer and Global Head of Fixed Income. He is a member of Neuberger Berman’s Operating, Investment Risk, Asset Allocation Committees and Fixed Income’s Investment Strategy Committee, and leads the Fixed Income Multi-Sector Group. From inception in 2008 through 2015, Brad was also Chief Investment Officer of Neuberger Berman’s Multi-Asset Class Investment business and remains an important member of that team along with the firm’s other CIOs. From 1990 to2002, Brad was director of fixed income for Strong Capital Management in Wisconsin. He was also a member of the Office of the CEO and headed institutional and intermediary distribution. In 1997, Brad was named “Runner Up” for Morningstar Mutual Fund Manager of the Year. From 1982 to 1990, he was a vice president at Salomon Brothers in the government, mortgage and financial institutions areas. Brad earned a BBA and an MBA from the University of Wisconsin.

Anthony Tutrone, Global Head of Alternatives
Anthony Tutrone is the Global Head of NB Alternatives and a Managing Director of Neuberger Berman. He is a member of all Neuberger Berman Private Equity’s Investment Committees. Anthony is also a member of Neuberger Berman's Partnership, Operating, and Asset Allocation Committees. Prior to Neuberger Berman, from 1994 to 2001, Anthony was a Managing Director and founding member of The Cypress Group, a private equity firm focused on middle market buyouts that managed approximately $3.5 billion of commitments. Anthony began his career at Lehman Brothers in 1986, starting in Investment Banking and in 1987 becoming one of the original members of the firm’s Merchant Banking Group. This group managed a $1.2 billion private equity fund focused on middle market buyouts. He has been a member of the board of directors of several public and private companies and has sat on the advisory boards of several private equity funds. Anthony earned an MBA from Harvard Business School and a BA in Economics from Columbia University.
“How do central banks respond to this inflation? Their policy tools are less effective against supply bottlenecks or rising wages.”

– Erik Knutzen



Macro: Entering a New Age

Brad Tank: We are now settled into this new business cycle, so let’s think about what kind of cycle it’s going to be.

After the disruption of the Great Financial Crisis (GFC), a lot of commentators expected a phase of short, volatile business cycles. There were events like the crisis in Greece and the wider eurozone or the emerging markets and commodities downturn in 2015 that, in previous decades, might have tipped the balance. But nothing knocked the global economy off course, and the record-breaking expansion may well have persisted without the exogenous impact of the pandemic. There has been a trend toward longer cycles in developed economies, due in part to the shift away from manufacturing to services, and to more efficient, globalized, just-in-time supply chains. But the most important new element was the post-GFC ability and willingness to support the cycle with substantial monetary and fiscal policy interventions. That included emergency measures, such as Mario Draghi’s “whatever it takes” extension of the European Central Bank’s mandate, but also measures that far outlived the emergency, from zero rates and quantitative easing (QE) to President Trump’s late-cycle corporation tax cuts. When the pandemic hit, we doubled down with those new tools. QE was extended to all kinds of assets and fiscal policy now appears to be limitless—or at least, the global bond market appears pretty accepting of it, so far. That suggests to me that the base case is another long cycle, backed by a central bank and fiscal policy “put option.”

Joseph Amato: I think the big caveat is that everything is happening much faster in this cycle. Hitting the trough and achieving the recovery was a much shorter process than in previous recessions. And while there is generally a mid-cycle feel to things now, there also seems to be a lot of late-cycle bubbles and substantial inflationary pressures.

We’re also thinking harder about one of the themes from last year: “Supply chains become shorter and more diversified.” We’ve seen that in corporate decision-making. As you’ve written, Brad, one of the reasons we are likely on course for higher inflation in this cycle is because companies are taking long-lasting action to tackle a transitory—but extremely disruptive—supply-and-demand crunch. If you open two or three locations across Asia to take the slack of your big one in China, or you re-shore production, or you start carrying more “just-in-case” inventory, that is likely to eat into earnings for a time, exacerbate inflation, and potentially bring back some pre-1980s volatility to the business cycle.

Erik Knutzen: For some of the reasons Joe outlines, I think we could be in for a long expansion, supported by central banks and fiscal stimulus when necessary, but with heightened volatility. And I mean volatility in economic activity and data, volatility in politics and policy, feeding through into volatility in financial markets.

Tank: I agree there are reasons to expect that kind of volatility over the short term, and that could extend through the coming year. But longer term, I believe that the central bank and fiscal “put option” continues to be a volatility dampener—at least until markets stop believing in it. What could cause a loss of faith? A crack-up in inflation and rates could be a threat, or a bubble bursting. This time last year, we did not see a threat of substantial reflation. We thought 5% was the ceiling and that the peak would be in the second or early third quarter. Well, we just got the September reading and it’s up again, to 5.4%. It’s higher than we expected, and stickier than we expected.

Knutzen: This is why the inflation question is so critical. And it’s not only a question of transitory or secular, but also how much is driven by supply-side, cost-push factors as opposed to demand-pull factors. Right now, I believe it’s both: pent-up spending meets broken supply chains. Over the medium term, however, the new and significant inflationary dynamics are likely to be supply-driven. Joe mentions “just-in-case” supply chains. There’s the sustainable energy transition, where we could see more supply crunches before we get full capacity with renewables. China used to export disinflation to the rest of the world with its low-cost workforce, but that really faded out a decade ago and its more recent strategic orientation appears to cap the end of that era. And China’s “common prosperity” theme could be reflected globally: the tussle between labor and capital for the spoils of growth tends to go through 20- to 30-year cycles, and profits have outgrown wages since the early 1980s. There are political, structural and demographic reasons to expect labor to capture more over the next generation.

How could central banks respond to this kind of inflation? Their policy tools are less effective against supply bottlenecks or rising wages. They can only step in to dampen demand. But demand isn’t the problem, and dampening it could risk triggering recessions. Over the longer term, capex, technology, automation and general productivity enhancements should be the answer. But over the next year, cost-push inflation and how monetary authorities respond to it are likely to be a key source of potential risk.

Suzanne Peck: One could make a list: the energy transition, China’s “common prosperity” objective, President Biden’s “human infrastructure” fiscal program, the E.U. “Next Generation” fund and environmental program, re-shoring essential supply chains, the required investments in productivity enhancement, the role of central banks. Underneath, there’s a real sense that government has a dramatically enhanced role in the economy. That suggests more regulation and more taxation for both corporations and investors. From the standpoint of the taxable wealth management client, that reinforces a point we have been making for some time, which is the key role of tax-efficient investment strategies that take systematic advantage of opportunities for tax-loss harvesting and tax deferral.

Tank: Absolutely, and it goes further. One of the big lessons of the current inflation spike is that government interventions have dampened the role of market price signals in the allocation of resources. Wages are rising and there are vacancies across many sectors, but, in the U.S., the labor participation rate is well below the pre-pandemic level. Energy prices have spiked, but demand is still there, because governments have spent decades supporting and subsidizing energy consumption: gasoline, for example, has tended to become cheaper and cheaper for the U.S. consumer over the long term, so price spikes have less real impact on demand. Many consumers can afford higher fuel taxes, but governments won’t go there. The irony is that the corporate and financial sectors have often led governments on climate change. Compare the commitments made by the Net Zero Asset Managers Initiative, the Net Zero Asset Owner Alliance, and a huge range of companies, with the foot-dragging on Paris Agreement commitments leading up to COP26. We are advocates of market solutions, but the substantial decisions will likely be made in Washington and Brussels, and they fear the political side effects of market medicine when it comes to sustainability.

Amato: This underlines the importance of identifying and managing these potential risks in portfolios. Sustainability-related investments, even if they can potentially deliver long-term growth, could present short-term costs. But the consumer, political, regulatory and investment agenda can change very quickly, and the more they are driven by politics, the more volatile progress is likely to be. It could mean more supply-and-demand mismatches, inflationary episodes and sudden repricing of assets. Adam Smith’s famous “Invisible Hand” has become the conspicuously visible hand of government in Europe and the U.S.—and China’s visible hand is becoming especially assertive.

“We believe a mix of these short-duration, less-correlated and tactical sources of income is likely to pay dividends in the year ahead.”

– Brad Tank



Fixed Income: Rates Adjust, Investors Embrace Flexibility

Amato: Alongside the reversal of 30 or 40 years of deregulation and government removing itself from the economy, we may also be at the end of 40 years of declining inflation and interest rates. What could this mean for the many investors, both institutional and individual, who rely on long-duration assets?

Anthony Tutrone: Might the withdrawal of central bank asset purchases be the catalyst to kick yields up?

Tank: Our view is that rates are on their way up. But the pace of the adjustment is as important as the direction. We believe it will be gradual and orderly. It’s worth remembering that we are into November and we still haven’t reached our year-end target for the 10-year Treasury yield—with inflation above 5%. It felt like we might blow through it back in March, but demand for fixed income assets is overwhelming, and that is keeping yields low, curves flat and credit spreads, in our opinion, priced for perfection. Finding income with modest or no duration will likely continue to be the priority, in our view, and credit selection should take over from the early-cycle, “credit-beta” play, but market disruption or significant credit issues appear unlikely.

Faced with this combination of low and rising rates and tight credit spreads, investors are likely to double down on their search for short duration, floating rate, and less correlated sources of income. They may complement this with more tactical positioning whether that be in interest rate risk exposure, asset allocation or into narrower, niche, but attractive markets. What does that mean, specifically? We think we’ll see more attention on short duration credit, loans, collateralized loan obligations (CLOs) and securitized investments, for income with modest duration. Opportunities such as taxable municipal bonds, local-currency emerging markets debt and China bonds could provide less correlated income for those able to move in those directions. And the tactical opportunities might include corporate hybrid securities in Europe or bank capital securities in the U.S. We believe a mix of these short-duration, less-correlated and tactical sources of income is likely to pay dividends in the year ahead.

Amato: It’s notable that you mention China bonds for their attractive yields and diversification benefits. At the same time, China is the one major market where we are starting to see disruption and significant credit issues. Our local team covering the A-Share equity market emphasizes the continuity in the government’s recent regulatory announcements, but they also note that the new articulation of those goals will create new winners and losers. Sustainable energy and 5G connectivity are likely to receive a strong tailwind, but other types of infrastructure and especially real estate now face headwinds, as do some other sectors, from private education to e-commerce.

Knutzen: Our colleagues in China have written about how important it is to understand that it is a policy-driven market. That policy is evolving—but it doesn’t suddenly make China an uninvestable market. It’s about allocating to the opportunities that the authorities have identified as priorities.

Tank: For fixed income investors, it’s a complex but interesting opportunity set. We do think the government is likely to ring-fence Evergrande, thereby containing much of the volatility in the high-yield property sector. Spreads in investment-grade corporates and financials are tight, due to a flight to quality, but China’s monetary and fiscal policies are now moving in a more accommodative direction than in most developed markets, and that could support China government bonds, offering attractive yields and the potential for spread-tightening against developed market government bonds.

“For really attractive opportunities, we think the value style is more interesting, and especially equity income as a subset of value.”

– Joseph Amato



Equities: Reflationary Themes

Amato: In equities, generally speaking, we think the reflationary environment is likely to lend support to sectors such as Materials, Energy, Industrials and Financials over Consumer Staples, Healthcare and Communication Services, as well as value over growth stocks. Longer-duration growth stocks have been recovering since Treasury yields hit their peak in March 2021, but as yields start to edge up again, value is likely to reassert itself. If we get a weaker U.S. dollar over the coming years, which is the Equity Team’s core scenario, that could add impetus to these dynamics.

Knutzen: Our Asset Allocation Committee (AAC) follows through on that with its latest regional market views. We generally favor non-U.S. developed and emerging equity markets over U.S. large caps, which reflects that reflationary, weaker-dollar outlook. Within emerging markets, however, we downgraded our view on China to neutral while upgrading India to an overweight, particularly its technology and innovation sectors, which we see as emerging as centers of development to rival others in Asia.

Amato: I think emerging markets face significant challenges. They have fewer fiscal resources to battle the economic impact of the pandemic. It has generally had less access to vaccines, which has meant either higher incidence of COVID-19 or greater and longer-lasting reliance on lockdowns and social restrictions. They are also generally more exposed to supply-chain disruption, inflation risk and the slowdown in China. There are pockets of opportunity, but I believe emerging markets as a whole are not the clear opportunity they would usually be at this stage of a cycle.

For really attractive opportunities, we think the value style is more interesting, and especially equity income as a subset of value. The price-to-book ratio of the S&P 500 Dividend Aristocrats Index relative to the broad S&P 500 remains 18% below its long-term average and has only just started to recover from its trough during the pandemic.1 Moreover, while there is strong correlation between high starting valuations and the subsequent 10 years’ total return, the more important dividends are as a proportion of a portfolio’s total return, the weaker that correlation becomes. That’s worth noting if you’re concerned about market valuations.

Income is also interesting if you believe we are in an environment of structurally higher inflation. Global dividend growth has been highly correlated with U.S. inflation: dividends tend to grow faster than inflation, because they are generally paid out as a ratio of nominal earnings. That is why, over the past decade of subdued inflation, declining rates and outperforming growth stocks, European and U.S. dividend growth have been very subdued. Since 1945, S&P 500 dividends have grown by 6.5%, annualized, and have never grown by less than 2.2% during any 10-year period, making the past decade very unusual and suggesting a lot of catch-up potential. In addition, the relative stability of traditional income stocks’ earnings and dividend growth has tended to make them much less sensitive to changes in interest rates than the growth stocks that are now so dominant in large-cap indices, and that could be advantageous in a rising-rate environment.

Knutzen: This is really important for investors to bear in mind when they think about the challenge of dampening portfolio volatility and introducing some inflation exposure while also trying to avoid introducing a lot of interest-rate sensitivity. Increasing the traditional government bond allocation raises portfolio duration. Instead of that, dividend income may have a role to play here.

Amato: That may be one reason why flows into developed market dividend-focused funds appear to have picked up quite sharply since the spring of this year.

“There are two key reasons to consider private markets right now. First, it’s an abundant source of opportunistic investments. Second, execution risk, not market risk, is most likely to determine success.”

– Anthony Tutrone



Alternatives: No Longer Alternative

Knutzen: Let’s dive further into that question of how to diversify a portfolio against the potential downside risk in equities at a time of low and rising core government bond yields. Inflation adds another layer of complexity: many investors are looking for assets that can diversify potential downside equity risk, mitigate the impact of inflation, or both. Moreover, some assets have been effective against short-term inflation spikes while others have done a better job of outperforming more persistent inflation. The result is that we see many investors lengthening their menu of alternatives and allocating more to them.

China bonds were effective diversifiers during 2020, while also offering attractive yields. Idiosyncratic and uncorrelated strategies are in demand, but selectivity is important. We’ve been talking about how government involvement in the economy is dampening market price signals: that appears to be a key reason why many macro hedge funds have struggled, alongside some of the classic market-neutral styles. Merger activity is creating opportunities for event-driven strategies, on the other hand, and Hurricane Ida and Germany’s summer floods might have opened up value in insurance-linked strategies. On inflation, we are seeing interest in commodities to mitigate short-term spikes, and private and listed real estate to absorb the longer-term trend.

Peck: Individual investors talk about similar challenges and responses. They are increasingly willing to consider illiquid assets, as the asset management industry creates new fund structures to make them more accessible. There is growing recognition that giving up some liquidity, which we often don’t need, can meaningfully boost potential portfolio returns or yield profiles. There is also more awareness of the range of opportunity that exists outside the public markets. One interesting knock-on effect is a blurring of the lines between public and private markets. That is significant: if you regard private equity as part of your equity bucket rather than part of an alternative or illiquid bucket, you may allocate more—particularly when there is such an attractive relative-returns case.

Tutrone: I think there are two key reasons to take a closer look at private markets right now. The first is that it’s an abundant source of opportunistic investments; and the second is that execution risk, not market risk, is most likely to determine success. Within our private markets business, for example, we have been structuring preferred stock capital solutions for private companies. These investments have the potential for near-private equity return profiles, but mostly in the form of contractual returns, and at less than half the valuation multiple of the same company’s common equity. Why such an attractive risk-reward profile? Because these private companies need capital to pursue growth opportunities, but their owners don’t want to dilute their common equity or increase financial leverage: preferred stock fills that gap between debt and common equity.

Those growth opportunities relate to the other point about execution risk. We see a meaningful tilt toward high-growth companies across the industry and in our own portfolios. In our co-investments, the proportion of companies projecting annual revenue growth in excess of 10% has more than doubled over six years, to around two thirds of our deals. Moreover, the equity in the average private equity deal is now more than 50%. As a result, generating private equity return opportunities is no longer about buying cheap and heaping on leverage: it requires earnings growth. Private assets, like public assets, aren’t cheap anymore. That’s one reason why the focus is now on the execution plan for taking advantage of growth opportunities. The main difference between public and private investing is that there is much more you can do as a private owner to ensure that the risk you take is business execution risk and not valuation risk. We believe that, in today’s environment, the ability to tilt the playing field in that way is meaningful.

“Government now has a dramatically enhanced role in the economy. That suggests more regulation and more taxation. From the standpoint of the taxable wealth management client, that reinforces the key role of tax-efficient investment strategies.”

– Suzanne Peck

Webinar Replay
As 2021 draws to a close, the leaders of our investment platforms gathered to talk about the key themes they anticipate for 2022.
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