To present Parametric’s views on the investing environment in 2024, I canvassed my colleagues for their insights on topics of particular interest to institutions. Here’s what we think matters most to institutional investors this year.
Interest rates may be higher for longer than investors think
With the market pricing in several Federal Reserve rate cuts over the course of 2024, it’s not a stretch to state that we believe short-term rates have peaked. Over the past several decades, the 12-month period following the final Fed rate hike has produced attractive corporate and municipal bond returns for opportunistic investors—with the greatest benefit typically going to those who have acted early.
Equity diversification is still a prudent approach for patient investors
No one needs to be reminded how significantly the “Magnificent Seven” stocks contributed to overall equity index returns in 2023. Those who were underexposed to these names paid a potentially heavy penalty in the game of active management.
Volatility could increase if both rate and equity markets surprise to the downside
Amid a surprisingly tepid volatility environment, market expectations of future short-term volatility decreased steadily in 2023, with the VIX Index reaching levels not seen since before the Covid pandemic. As inflation cooled and the Fed neared its peak policy rate, investors may have become more comfortable about the relative direction of rates. At the same time, correlations across individual equities dropped, lowering overall index volatility.
Commodities belong in a well-diversified portfolio
We expect investors to remain constructive on real assets, given that inflation continues to run stubbornly above 2%. The healthy labor market, resilient consumer demand and volatile geopolitical forces are likely to keep prices elevated. Investors may wish to consider adding broad exposure to commodities, which are known for their sensitivity to inflation. And thanks to their low correlation with traditional marketable asset classes, commodities may also serve as a source of portfolio diversification in the wake of converging stock-bond movements.
Pension risk management strategies can help to preserve funded status
Exceptionally strong equity market returns and somewhat stable interest rates in 2023 pushed pension funded status higher. For the second year in a row, the Milliman 100 Pension Funding Index finished above 100%, with 2022 and 2023 being two of only four years since 2000 that has happened. We would point out, however, that after 2000 and 2007, the other two years with funding above 100%, markets were not kind to the average pension plan.
Liquidity and leverage strategies need to take prevailing rates and risk premia into account
Our institutional clients are increasingly seeking ways to boost returns on cash. The typical custodial short-term investment fund (STIF) vehicle tracks three-month Treasury Bills closely. But now that fees waived for years in the wake of the Fed’s Zero Interest Rate Policy have been re-instituted, investors are paying 10 to 15 basis points on average for money market returns, which isn’t overly attractive.