Insight is Capital™ Podcast

Fidelity's Ilan Kolet – 11 Questions for 2024

Mon Feb 12 2024

monetary policyinvestment strategyinflationUS marketportfolio managementfund managementglobal monetary policycentral banks

Description

Ilhan Kolet, institutional portfolio manager in Fidelity's Global Asset Allocation Group, discusses frequently asked questions from advisors and investors at the start of 2024. Topics covered include the expected path of monetary policy, the trade-off between balanced mandates and cash instruments, inflation and stock-bond correlation, optimism about the US market, investment strategy and portfolio management, success and resources in fund management, monetary policy and inflation, and global monetary policy and central banks.

Insights

Investing in well-diversified multi-asset class funds provides a longer trade-off between risk and return compared to GICs.

Over the past 10 years, $1,000 invested in a GIC would have grown to just over $1,100, while the same amount invested in a globally diversified 60/40 portfolio would have grown to $1,900.

Inflation erodes the purchasing power of every dollar and affects stock-bond correlation.

Investors should be concerned about inflation as it impacts their portfolios. The 1970s were a prime example of how elevated inflation eroded the stock bond correlation.

Optimism towards the US market is driven by a change in view and the possibility of a productivity boom.

The US is less interest rate sensitive than before due to lower household debt and mortgage refinancing. If a productivity boom occurs, inflation can continue to fall, the labor market can remain strong, and earnings and equities can perform well.

Investment strategy focuses on being opportunistic in some parts of the equity market and overweighting credit and spread sectors.

The funds are currently neutral in terms of duration and investing less in Canada relative to other opportunities. Having a single ticket portfolio managed by a team of portfolio managers simplifies decision-making.

The speaker emphasizes the proven track record of success and returns, as well as the importance of research and execution.

Scale is mentioned as a benefit, with access to resources from an organization managing $900 billion globally. Adding well-known managers like Will Danoff provides an advantage.

The US dollar losing its reserve currency status is overblown, and lessons have been learned from past episodes of quick rate cuts.

The Bank of Canada needs to be careful not to harm the Canadian housing market and businesses while seeking sustained improvement in underlying inflation. The Federal Reserve will make changes gradually and cautiously.

Chapters

Expected Path of Monetary Policy
Balanced Mandates vs Cash Instruments
Inflation and Stock-Bond Correlation
Optimism about the US Market
Investment Strategy and Portfolio Management
Success and Resources in Fund Management
Monetary Policy and Inflation
Global Monetary Policy and Central Banks

Summary

Transcript

Expected Path of Monetary Policy

00:00 - 08:10

There has been a significant change in the expected path of monetary policy, particularly in the US. This has led to a material change in positioning around the US and increased optimism.
The high conviction view is that the US will outperform this year and monetary policy doesn't need to be as restrictive as before.
The market quickly priced in rate cuts while the Fed only telegraphed three. There is uncertainty about whether the market is right or not.
With improvements in underlying inflation and slight rise in unemployment rate, rates don't need to be as restrictive. The Fed recognizes this and wants to avoid being late to rate normalization.
Rate cuts are seen as the right move, but there is no precision on specific dates or cumulative amount of rate cuts for 2024.
Taking their foot off the brake could create uncertainty and potential inflationary pressures in certain parts of the economy.

Balanced Mandates vs Cash Instruments

07:45 - 15:08

The question of why investors should consider balanced mandates or asset allocation funds instead of cash instruments or GICs is addressed. GICs were favored due to risk aversion and high guaranteed rates of return.
The argument made is that there is a longer trade-off between risk and return, favoring balanced mandates for better long-term outcomes.
Investing in a well-diversified multi-asset class fund provides a longer trade-off between risk and return compared to a GIC.
Over the past 10 years, $1,000 invested in a GIC would have grown to just over $1,100, while the same amount invested in a globally diversified 60/40 portfolio would have grown to $1,900.
Even if an investor had a 5% GIC every year for the past 10 years, it would only result in $1,600 compared to almost $2,000 in the multi-asset class fund.

Inflation and Stock-Bond Correlation

14:44 - 21:52

Inflation erodes the purchasing power of every dollar, which affects investors' stock and bond correlation.
The 1970s were a prime example of how elevated inflation eroded the stock bond correlation.
Investors should be concerned about inflation because it impacts their portfolios, not just relative to benchmarks.
Canada is a high conviction underweight due to concerns about household debt and higher borrowing rates.
Being underweight the Canadian dollar helps protect portfolios in case of stress or negative sentiment.
Underlying managers in Canada are also underweighting Canadian banks, which have traditionally been cornerstone investments for many portfolios.
Even if Canada underperforms, if the underlying managers outperform their benchmarks, it can still be a win for investors.
The highest conviction overweight is on the US, with optimism towards the US dollar.
There has been a shift from being roughly neutral beta to leaning towards overweighting US assets.

Optimism about the US Market

21:36 - 28:51

The speaker is now overweight equities, particularly in the US, due to a change in view.
The increased likelihood of a soft landing in the US is one of the main reasons for the change in view.
The US is less interest rate sensitive than before due to lower household debt and mortgage refinancing.
Mortgage interest cost deductibility is seen as a meaningful perk for homeowners.
The second reason for being optimistic about the US is the possibility of a productivity boom or product recycle.
If this scenario plays out, inflation can continue to fall, the labor market can remain strong, and earnings and equities can perform well.
This optimistic scenario has happened in the past during the mid to late 90s with the advent of the internet.
Ken Griffin mentioned that it's currently a good time for 60/40 investors in the market.
It's unlikely that there will be further rate hikes, making it potentially a comeback year for bonds.

Investment Strategy and Portfolio Management

28:32 - 36:06

The likelihood of rate hikes is very low and the possibility of rate cuts is high.
The funds are currently neutral in terms of duration and focusing on being opportunistic in some parts of the equity market.
They remain overweight on credit and spread sectors such as leverage loans and high yield bonds.
A return to a more normal correlation environment and closer proximity to monetary policy normalization would be needed to change their position on duration.
The gap between the current interest rates and neutral rates may be smaller if productivity growth and potential growth increase, which could impact bond optimism.
They have an overweight position in US equities but are investing less in Canada relative to other opportunities.
Shaving 7% from the Canadian equities allocation is expected due to relative outperformance in other markets, but beating benchmarks can boost overall fund performance.
Having a single ticket portfolio managed by a team of portfolio managers can simplify decision-making for advisors and investors.
Execution is the challenging part of investing, but their portfolios offer simple and elegant solutions to complex problems through diversification, rebalancing, and asset allocation decisions.
Their multi-asset class approach has a proven track record of success compared to blindly passive 60/40 portfolios.

Success and Resources in Fund Management

35:39 - 43:01

The speaker emphasizes the proven track record of success and returns of their investment process, surpassing benchmarks over various time periods.
They express personal conviction in their process and are personally invested in the funds they manage.
The speaker highlights the challenge of making informed investment decisions and the importance of execution.
Scale is mentioned as a benefit, with $80 billion managed for Canadian investors and access to resources from an organization managing $900 billion globally.
The speaker mentions using the same infrastructure, analysts, risk metrics, and research team as the larger organization, which provides advantages in decision-making and portfolio management.
They discuss the ability to rebalance funds whenever desired and add new capabilities or asset classes when needed.
The speaker mentions adding well-known managers like Will Danoff to their strategies for an advantage.
A chart is referenced showing how their Canadian sleeve outperforms the TSX index while smoothing volatility through combining underlying Canadian equity managers.
Research is emphasized as crucial in every aspect of fund management, from manager selection to asset class construction and tactical decisions.
Lastly, they mention including a question about the US dollar losing its reserve currency status in their paper.

Monetary Policy and Inflation

42:54 - 50:21

The idea that the US dollar is about to lose its reserve currency status is overblown when looking at the data.
The Bank of Canada may cut rates, but progress on inflation has been less convincing than in the US.
The bank needs to be careful not to harm the Canadian housing market and businesses while still seeking sustained improvement in underlying inflation.
The language and expectations around monetary policy in Canada are expected to evolve in the coming months.
There is a concern that cutting rates could cause a resurgence in inflation, but the odds of that happening are low.
Goods prices have returned to pre-COVID rates, so service prices are now the main contributor to inflation.
Service prices have slowed down, especially in the US, which has resulted in a 1.9% six-month annualized rate of core PCE.
Lessons have been learned from past episodes where quick rate cuts led to an inflationary surge.

Global Monetary Policy and Central Banks

50:05 - 52:18

Global monetary policy and central banks have learned lessons from past episodes.
The Federal Reserve will make changes gradually and cautiously.
The Fed doesn't want to be too restrictive for too long.
Inflation in the US is heading in the right direction.
Rates don't need to be as restrictive as they have been.
The speaker has enjoyed the conversation and recommends reading their white paper.
Advisors can find the speaker through Fidelity wholesalers.