January 24, 2024 | In this issue of The Institutional Risk Analyst, we feature William Kennedy, co-founder and CEO of RiskBridge Advisors, an Outsourced Chief Investment Officer (OCIO) firm serving endowments & foundations, insurers, family offices, and their principals. Bill has decades of experience in the financial industry and was most recently CIO of Fieldpoint Private Bank. We spoke with Bill at The Lotos Club of New York earlier this month.
The IRA: Bill, you have been heading RiskBridge Advisors since 2020 and have guided your clients through some difficult times. Tell us about the business and where you are putting client assets as 2024 begins.
Kennedy: We launched RiskBridge with a vision to “serve those who serve others.” After three decades at large firms with conflicted agendas, my calling seemed to be to create a boutique investment advisory firm dedicated to serving others by helping them grow their businesses, find more cures, award more scholarships, and offer more community services. The RiskBridge team believes this is a good reason to open the doors each day.
The IRA: Those are good reasons. What was it like starting a business during COVID?
Kennedy: Starting RiskBridge in July 2020 felt crazy. Looking back, however, I think our timing might have been pretty lucky. The risk landscape and investment problems stemming from the pandemic created a strong demand from insurers, foundations, and individuals to think about investment risk differently. Today, we advise on $85 billion in client assets, including $600 million of discretionary assets under management across about 50 clients. We offer institutional advisory services, outsourced chief investment officer solutions, and private wealth management.
The IRA: There are several trillion dollars in assets being supported by outsourced CIO services such as yours, according to Institutional Investor. Several large players, including Vanguard and Goldman Sachs (GS), have created OCIO efforts. In fact, Mercer just acquired the OCIO business from Vanguard. Walk us through the value proposition for funds vs a full-time CIO.
Kennedy: Whether it’s an institution or a family office, the decision to hire and retain a dedicated CIO is a question of mission, scale, and complexity. Does an in-house CIO enable the mission of the organization or the family? Are the assets under management large enough to cover the overhead costs associated with an in-house CIO? Is the organization or family structure complex enough to justify hiring a dedicated internal CIO, who often wears multiple hats? These are just a few considerations. It may make more sense for organizations to hire a discretionary OCIO if an investment committee or family wants to streamline decision-making, implementation, and governance without giving up control.
The IRA: Volatility remains perhaps the biggest risk factor today, mostly because of a lack of visibility on unexpected risks. The failure last year of three large banks with half a trillion dollars in assets surprised many. We told our readers to beware duration risk ℅ QE in 2017. You and many of our colleagues got the joke. Yet an awful lot of people don’t seem to be able to follow the Fed, interest rates and jobs.
Kennedy: The cornerstone of our investment philosophy is that the quantity and types of risk allowed in a portfolio are the primary determinants of future returns. We use volatility targeting to construct investment portfolios. Then, we manage the portfolio within a disciplined risk band no matter what the market throws our way.
The IRA: So you assume the volatility and prepare accordingly?
Kennedy: Yes. This approach was useful when equity and credit volatility spiked in 2022 and again in 2023 when rate volatility spiked following the collapse of Silicon Valley Bank. RiskBridge’s process blunted the pain of the 2022 bear market and spent much of the 2023 bull market playing catch up. Looking ahead to 2024, we are reminded that a hypothetical $1,000,000 portfolio invested in 60% stocks and 40% bonds returned $988,888 on December 31, 2023. In a way, 2023’s bull market was the mirror image of 2022’s bear market. Maybe 2024 will be more normal.
The IRA: So where are you putting money now?
Kennedy: From a strategic perspective, we are reminding clients that we remain in the shadows of a worldwide pandemic that shut down swaths of the global economy. On the one hand, market resiliency is remarkable. On the other hand, we don’t think there has been anything “normal” about the policy or market landscape since 2020. As we move one year away from the surreal nature of the pandemic, we hope 2024 will be a bit more recognizable.
The IRA: Meaning more normal? How do you assess and measure risk?
Kennedy: From a tactical perspective, our risk models are constructive. Liquidity and financial conditions in the U.S. are positive, although Chinese liquidity looks problematic. Our business cycle indicators indicate a downturn characterized by slowing growth and stable inflation. One area flashing amber is cross-asset correlations. We see odd behavior between stocks, credit, rates, and commodities, which could imply market turbulence ahead.
The IRA: The big change since 2008 and COVID is a breakdown in correlations that heretofore seemed quite solid. How do you feel about soft landings?
Kennedy: We believe we are in a downturn regime characterized by slowing economic activity and stable inflation. We think 2024 U.S. real GDP could be 1.8% and inflation 3.0%. If our outlook turns out to be correct, 4.8% nominal growth should continue to support free cash flow generation and generally support risk assets. The question is how much of that is already discounted in current stock prices and credit spreads.
The IRA: Look at JPMorgan (JPM). Jaime Dimon broke a record on annual earnings because of Q1 2023, but the numbers in Q4 2023 were down 40% sequentially, fell to single digits in fact. Bank earnings have been down for five quarters in a row and the Q4 earnings suggest that Q1 may also be light. Typically, Q1 is the best quarter of the year for many banks and other financials. How are you approaching allocation across the various market segments?
Kennedy: In our Investment Outlook for 2024, which is available at www.riskbridgeadvisors.com, we highlighted four “Ds” as our investment themes for 2024: Debt, Deglobalization, Demographics, and Downturn. We think the deglobalization theme will be characterized by shifting global interdependencies. We believe this will be a slow-burning theme, creating opportunities for emerging markets ex-China (debt and equities), infrastructure, aerospace and defense, and the global material sector.
The IRA: Sounds like you are not expecting a hard landing. What themes do you think are helpful in 2024?
Kennedy: The aging boomer generation theme is well known. We are playing it through funds with biotech, life sciences, and financials exposure. One theme we believe to be underappreciated by the market is the U.S. demographic profile, which distinguishes itself amongst the G-10. This may support consumption and household formation for several years ahead. In equities, we are allocating to active managers (long-only and hedged), where we have identified deftness at playing the dispersion between winners and losers. We prefer dividend-payers, high quality, and a SMID-bias.
The IRA: How do you feel about interest rates? We have been watching the long-end of the Treasury yield curve back up since the New Year.
Kennedy: We are tactically underweight fixed income duration with exposures in floating rate notes, high yield, and cash equivalents. This is because we expect higher yields related to the debt issuance theme. In addition to our shorter duration strategies in fixed income, we also like hedged credit, which we think should benefit from dispersion and the importance of credit selection. For companies with business models and capital structures that flourished in a low rate environment, higher rates and an uncertain economic picture are challenging their sustainability.
The IRA: Don’t hold your breath waiting for MBS spreads to contract. The signals remain very confused. We saw a lot of names in consumer facing businesses run in financials in Q4 2023, including Ally Financial (ALLY) and CapitalOne (COF), all on the assumption of a “soft landing” aka lower rates. But if the FOMC restarts QE and reinvestment of portfolio runoff this year, then why are we cutting the fed funds rate?
Kennedy: We expect Fed Funds to end the year around 4.50%-4.75%. This implies higher yields for the 2-year and 10-year parts of the curve. Our view for higher yields is supported by an assumed $1.3 trillion in new Treasury issuance, which may cause some market indigestion. For this reason, we are tactically underweight fixed income duration with exposures in floating rate notes, high yield, and cash equivalents.
The IRA: We disagree on LT interest rates. Treasury Secretary Janet Yellen has a spending problem. We are one failed Treasury auction away from a US financial crisis. Of course, if you successfully autorotate a stalled Blackhawk helicopter that might be considered a soft landing. Speaking of volatility, we worry that consumer credit loss rates may pop during 2024, making the people who loaded up on consumer facing exposures unhappy. Yet the markets are churning out some impressive new issue numbers in the debt markets, both in the US and Europe. Are investors worried about missing the boat on higher yields?
Kennedy: Part of the market enthusiasm is due to falling interest rates, and part is simply the huge amount of dry powder sitting in funds and corporate hands. This is not your father’s high yield market. In our view, quality is better, and there’s enough coupon to help mitigate anticipated spread widening. We like high yield and shorter durations. As mentioned, we also like emerging market debt on the assumption that emerging central banks will lead the rate cut cycle.
The IRA: What is your view on China? What is your favorite market in Asia?
Kennedy: We generally exclude China from our emerging market exposures. To use an aviation reference, we have either VFR (visual flight rules) or IFR (instrument flight rules) conditions in most markets and asset classes. When it comes to China, we feel like we are flying blind. It’s hard to manage it if you can’t measure it.
The IRA: None of the economic “data” from China deserves consideration. Paramount leader Xi Jinping will run the economy into the ground before giving up power. He is doing precisely that right now. There does not seem to be a Deng Xiaoping anywhere in sight.
Kennedy: Our active managers in Asia prefer Japan, India, and China. At 16.0x forward earnings, Japan and Australia look relatively attractive relative to their regional peers. The same may be said for Taiwan at 11.8x forward earnings.
The IRA: How do you see financials? We started to accumulate some Wells Fargo (WFC) because they are the most improved among the top-five names and still at a reasonable price, but you may well be able to buy many banks cheaper as the year progresses. If we start to see more significant bank failures in 2024, how will this impact your investment outlook?
Kennedy: Similar to 2023, our liquidity cycle and market models should capture future bank failures. These, in turn, impact our risk tolerance and portfolio optimization tools. We are not very good at the prediction game. When the facts change, our outlook will follow.
The IRA: Given your focus on family offices, endowments, and foundations, what is your most important message to these clients? How are their needs different from the large institutional shops?
Bill: With our institutional and individual clients, we continue to focus on three key messages. First, meeting one’s fiduciary duty is increasingly hard, given the complexities of a post-pandemic world. Fulfilling this duty requires expertise and experience. Inflation’s impact on insurers, nonprofits, and legacy assets is complex. Inflation is the ultimate enterprise risk factor. Higher interest rates and inflation reduce purchasing power. Finally, we think the best way to compound wealth over an investment cycle is to participate when times are good but protect during market drawdowns. By focusing on the quantity and types of risks in a portfolio, we think we can help our clients prepare, protect, and perform.
The IRA: Thanks for your time, Bill. Have a great year.
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