The U.S. stock market may have just survived several days of mayhem that peaked with the Dow Jones industrial average’s 1,100-point drop on Monday morning. True, call centers at retail mutual funds were overwhelmed Monday by investors worried about their retirement funds. But that doesn’t mean that investors at pension funds and educational endowments are cowering in a corner.
Far from it. To do their job effectively, these investors need to keep a cool head under fire as they protect the assets under their care from outsize market fluctuations — and the volatility this week is not much to fear. In fact, the preceding period of market tranquility was something out of the ordinary, agree most fund managers interviewed.
Amid the market tribulations this week, Institutional Investor checked in with participants in our May U.S. Investor Roundtable, an annual event where winners of II’s investor awards share their thoughts on the markets and investment challenges.
Not that drama hasn’t played into the current seesaw that chief investment officers have been riding. “It’s been a tough two weeks for the world,” admits Sandra Urie, chair and CEO of Boston-based Cambridge Associates, an advisory firm focusing on endowments and foundations, pointing to China’s currency depreciation, a flare-up of tensions between North and South Korea, and other concerns about the global economy. Still, she notes, the market drop, while painful, was not unusual in its speed and depth, as Cambridge focuses on percentage changes — 11 percent for the U.S. stock market — over actual point drops.
Urie, with 30 years of consulting experience, feels the long-standing quiet in the equities markets was more unusual than the volatility this week. “People get accustomed to the dominant pattern,” explains Urie, Institutional Investor’s 2015 Lifetime Achievement Award winner. She points at potential opportunity in emerging markets.
Fadi BouSamra, CIO of the Metropolitan Government of Nashville and Davidson County (Tennessee), agrees with Urie. “We’ve gone quite a long time without a reasonable correction,” he explains. That isn’t necessarily a good thing. Equity markets need a healthy correction to establish prices and have a check on risk. Some investors had reached levels of 70 or 80 percent equity, and margin borrowing around the world has reached high levels, he adds.
Continuing in a prescriptive vein, BouSamra says: “It’s a good healthy correction. People need to rethink their risk exposure.” At the Nashville pension fund, BouSamra, who took home II’s small public pension award, has long believed in diversifying away from equity, and now has 21 percent in alternative fixed-income strategies such as residential loans and commercial bridge loans and another 12 percent of the pension fund’s total $2.8 billion in assets in traditional fixed income. With equities worth only about one third of the pension fund, Monday’s market rout “was not a big move from a portfolio standpoint,” he adds.
Jason Matz, CIO of Carleton College, a small liberal arts institution in Northfield, Minnesota, already sold off global equity exposure. From May to mid-July, the $800 million endowment portfolio disposed of $101 million in holdings in Europe, Asia and the Far East; emerging-markets; and large-cap U.S. equity index components. Matz used the futures markets to sell positions synthetically to allow his equity managers to maintain their portfolio holdings.
“We could reverse those trades, but we’re not going to do that now,” says Matz, who picked up his award in May for small endowment manager. He echoes his fellow U.S. roundtable members by saying that “a little pullback or pause is healthy.” Matz notes that the VIX, a measure of implied volatility on the Standard & Poor’s 500 index, had been heading straight down since 2009. In a rarely seen move, the VIX jumped past 50 on Monday.
Following the market downturn, Matz finds potential new investment in emerging markets and their currencies “interesting,” as are the energy sector, commodity debt and equity. And, he adds, “finally I’m excited again to see hedge fund returns.”
For his part, Gregory Williamson, the new CIO of the American Red Cross, will judge the severity of the market volatility depending on whether it reflects changing expectations in economic growth or inflation, or if it is reflective of a low-liquidity environment and margin capital moves stemming from algorithmic trading and hedge fund leverage. In the first case, “investors should have both short- and long-term investment performance and allocation concerns.” In the second scenario he believes longer-term concerns should be minimal.
While Williamson, who took over the investment office on May 1, is constrained from disclosing portfolio adjustments at his new employer, he does say that long-term investors whose growth and inflation expectations have not changed will likely take little action as a result of the recent market volatility. The winner of II’s large corporate pension award for his investment prowess during seven years as CIO at BP America, observes that strategic and tactical investors have been adjusting their portfolios for weeks now. “They will continue to do so as volatility spikes and ebbs,” adds Williamson, “and as governments implement market and economic support programs, and as funds flow between asset classes and markets occurs.”
As U.S. equities broke their six-day losing streak Wednesday, spurred by good news on the U.S. economy and increasing confidence that interest rates won’t be raised in September, our award-winning investors’ thoughtful approach to extreme market volatility appears to be on target.
Follow Frances Denmark on Twitter at @francesdenmark.
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