Allocators Are Investing Like a Recession Is on the Way – Despite the Fed’s Promise of a Soft Landing

Investors including the Hawaii Employees’ Retirement System are searching out potential safe havens, such as real assets, distressed debt, and floating rate securities.

Cole Burston/Bloomberg

Cole Burston/Bloomberg

Investors are rethinking their portfolios in response to “out of control” inflation and concerns that the Federal Reserve’s planned interest rate hikes will push the U.S. economy into a recession.

Rising geopolitical risks, which have led to more fragmentation in the world economy, are adding to allocators’ bearish outlooks, according to Michael Rosen, chief investment officer at Angeles Investments, which both manages portfolios and advises outside clients. Many investors believe the Fed has been far too slow to raise interest rates and they aren’t waiting around to see the results before making changes.

“The Fed is way behind the curve and has let inflation get out of control,” Rosen said. “We’re already expecting lower returns going forward.”

Rosen spoke about his market fears at Alts LA 2022, an alternative investments conference held in Los Angeles last week, along with Howard Hodel, deputy CIO at the Hawaii Employees’ Retirement System, Bruce Richards, chairman and CEO of Marathon Asset Management, and Samantha Foster, who recently left her post as managing director in the Investment Office of the endowment of the University of Southern California. Foster has joined Russell Investments’ nonprofit group as a managing director.

Richards said he believes the Fed is behind in managing inflation because it spent much of 2021 claiming that it would be transitory. But that is clearly no longer the prevailing belief at the Fed. Indeed, according to February data from the U.S. Bureau of Labor Statistics, inflation was up 7.9 percent year-over-year.

“That transitory nonsense puts us behind,” Richards stressed. “We’re going into a recession. It’s not a matter of if, it’s when.” Richards, whose firm primarily invests in credit strategies, expects a recession to come in the second half of 2023 based on the level of inflation and other factors.


Rosen is even more bearish than Richards. “I think the pain will come faster,” he said, noting that the terminal Fed funds rate — or how much traders expect the Fed will raise rates — is 2.4 percent.

“If that’s the case, we’ll see double-digit inflation,” Rosen said. With all of these market conditions in mind, Rosen said that Angeles remains committed to its decision to eliminate its allocation to high-grade fixed income, a move it made two years ago. Angeles is holding onto cash to preserve liquidity during a downturn, despite the bite of inflation. Separately, the firm has also cut its exposure to hedge funds down to between one and two percent because of both disappointing returns and high fees.

Meanwhile, Hodel said Hawaii has taken steps to put more money into real assets. The pension fund is looking at floating rate investments in private credit, but it doesn’t yet have a good solution for stagflation. The fund also has a book of long-dated options. If nothing happens in the market, these can “just tick away.”

Richards, whose firm invests in distressed debt, also believes now is a great time for the asset class. Distressed debt funds, in generally, have found few investments amid the long bull market.

Foster was less ready to predict he market’s direction, but said one thing is clear: Investors have to think about their entire operation, including who they are investing for as well as their portfolio construction, before making allocation decisions.