Q&A: Institutional Portfolio Strategy

Q&A: Institutional Portfolio Strategy

Amy: Hi. I'm Amy Thomas, a strategist here at First Citizens Bank. On Tuesday, August 15th, 2023, our Director of Market and Economic Research Phil Neuhart sat down with Craig Letendre, Director of Institutional Portfolio Strategy, to talk about some of the unique challenges our institutional investors face. As a reminder, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for education purposes only.

Phil: Craig, thank you so much for being with us today. You and your team work with institutional clients—think everything from corporations to municipalities, endowments, pensions—where we manage those assets. So given the interesting environment we're in today, I'm really excited to sit down with you. So let's start with the equity market. Stocks have rallied pretty dramatically this year. The S&P 500 as of this recording is up 17% year to date. It's pretty incredible given that we're only mid-August to have that sort of rally. What do institutional boards think of the rally? Are they believers in it? What are they saying?

Craig: Yeah. Well, first and foremost, thanks for having me here today. Happy to talk about our institutional client base and the conversations we're having. So as it relates to US equity markets, I would say it's a pleasant surprise as we think about all the headwinds that we were looking at coming into 2023. So there was a cloudy outlook, and equities have climbed that wall of worry, and the returns are quite strong. So first and foremost, I would say clients have been pleasantly surprised with the level of returns—up around 17%. So it was a big relief after a challenging 2022.

In addition to that, where we are and how fast we've rose in the equity markets, there's a little sense of caution and concern whether we can hold these levels, especially as we enter a, you know, historically soft patch of the calendar, the seasonal calendar. So generally August, September you start to see markets be a little more volatile. So those are the conversations we're having with clients right now around the equity markets.

Phil: Understood. So we've had some volatility this August so far, but looking longer term—when you have a big rally like we've had this year and a big sell down last year, it's very easy for clients to focus on the near term, even the 12-month type performance of the portfolio. But institutional clients tend to have very long-term goals. How do you keep clients focused on the long term versus what's happening one year to the next?

Craig: Yeah. It's a good question. So market volatility always creates that environment of having a short-term, narrow focus. So with clients, our goal is to keep clients on the long-term path of success. So getting clients there takes a number of things. First and foremost, it's leveraging the market research that we have that's provided at First Citizens through yourself, Brent and other outlets. So we keep clients apprised through frequent conversations around historical market observations, um, how markets behave over the long term, which is that general path upwards—but understanding there's always going to be bumps along the road, zigs and zags. So education, first and foremost, is very powerful, um, in reminders to clients. But in addition to the market research, we find that it's always a good opportunity to reset, level set with clients, look at goals and objectives, look at risk tolerance and at the end of the day look at the asset allocation to make sure it aligns with the client's objectives in that it's suitable for their particular situation.

Phil: So Craig, in the institutional world, you're often managing clients' excess reserves, and in-perpetuity assets like endowments, the risk-managing portion of the portfolio—that fixed-income portion of the portfolio—is very important. So fixed income matters a lot in your world. We've had a major move up in yields across the yield curve since early last year. How has that changed the conversation around risk-managing assets, excess reserves, et cetera?

Craig: Yep. I can't think of a client conversation where this isn't a topic. It's timely. It's a hot topic. We're certainly diving in deep around, you know, the implications for portfolios and how clients should think about higher bond yields at this moment in time. So, you know, I think there's two things to emphasize on the front end, two going assumptions, which are, you know, fairly consensus in the marketplace, which is first and foremost—equities versus bonds over the long term. Just the level of returns. And if you look back over history and you look forward—still likely to see higher overall returns for equities versus bonds. But at the same time, what's really changed is looking forward, and the gap between fixed income and equity returns. So the relative return between the two—expected to be much more narrow going forward.

Phil: Tighter spread between the two.

Craig: Tighter spread. So with that going assumption, what we're talking about with clients is that for portfolios the implication is going to be more balanced returns going forward. You know, it depends on your portfolio objectives. Again, take this in the context of your own portfolio and strategy, but by and large, we're likely to see a more balanced contribution of returns across broad asset classes like fixed income, equities and cash. So there are opportunities that we haven't seen in quite a while, and we're looking to take advantage of that in certain portfolio constructs.

So keep in mind the way that we're managing assets, these are things that we're looking at on a daily basis, and we're incorporating into our investment process for clients. So as investment manager, we are, you know, looking to maximize returns and minimize risk for client portfolios.

Phil: So a question I know you all get a lot and a circumstance you see is a client has a short-term pool and a long-term pool, and they're interested in moving—if it's appropriate for the client—moving some assets from that short-term pool to the longer-term pool, but it can sometimes be difficult to decide when to make that decision, what the strategy should be there. What's your guidance for clients who are struggling with that circumstance?

Craig: Yeah. There's a number of situations that you can look at and, you know, try to determine the best course. Let's look at one where there are clients with short-term investment portfolios that are going to be fixed income-heavy, and they may have another asset pool for the long term in perpetuity. We often get questions around "Well, my reserves have built up. I've had a pretty good operating environment over the past few years."

Phil: "I'm earning yield. Interest rates are up."

Craig: "I'm earning yield. I'm happy I can get—depending on the portfolio contract again—anywhere between 4 to 6% in yield. Very attractive. Should I consider moving some to long term if I have that capability?" And the conversation there comes down to time horizon, and, um, where we are at this point of the market cycle with yields, um, in equity markets—we think a dollar-cost averaging approach where you look at allocating incremental amounts on a set frequency is a pretty prudent strategy. It can really limit downside risk to portfolios as you enter those more volatile times. So we've been seeing that clients have been deploying a dollar-cost average in those situations.

Phil: So, Craig, a broader economic question sort of for my own edification. You spent a lot of time talking to businesses, um, of all sorts across the nation. What are you hearing from business owners and those who run businesses in terms of the economy and the business environment? It's such a debate right now among experts on where are we in this economic cycle? What are you hearing?

Craig: I would say, first and foremost, the biggest concern that we've heard from clients over the past—really now it's been 6, 12 plus months—which is the availability of labor. It has not changed. So coming out of the pandemic, we know that was an issue. There was some hope that that would subside. It really hasn't.

Phil: It's interesting because the data—you see some loosening potentially. But same thing, when I'm on the road, I am hearing that as the number one complaint. Even if the labor market's loosening on the margin, it doesn't seem to be hitting people, uh, in a good way yet.

Craig: Yeah. So that's the top concern, but at the same time, I'll tell you more often than not, clients have told us that from a fundamental business perspective, they have not seen really any deterioration in, let's say, new orders or operating environment. And margins may be coming down a little bit, but they've been holding up quite well.

So from a fundamental business perspective, clients have been telling us they're in pretty good shape. So they're encouraged by even some of the broad data that we're seeing across the US economy and how resilient the US economy has been in the face of tighter financial conditions and higher interest rates. So that was all the concern in 2023, but by and large, the economy has been able to navigate some of those challenges so far in 2023.

Phil: Yeah, really incredibly resilient economy so far this year. Well, Craig, thank you so much. It was really enlightening. Thank you so much for taking the time to sit down with us today.

Craig: Absolutely. Thank you. I appreciate it.

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