2024 seems to be following the same pattern, with additional curveballs such as August’s yen “carry trade unwinds” adding to investor unease. Still, there are numerous reasons to believe that the differing policy platforms of Democratic presidential nominee Kamala Harris and Republican presidential nominee Donald Trump will have limited long-term impact on markets. Even in the event of a sweep by one party, both candidates have policy goals that may be constrained by wider market conditions and that contain inherent contradictions. For example, boosting US energy supply may depend on global oil supply/demand dynamics, most of which are outside a president’s control. Increasing the supply of goods while limiting their prices may also prove self-defeating. Despite the potential for deficits to increase under either candidate, interest rates may still decline as growth slows and inflation continues to ebb. Finally, there also may be more shared political ground than is realized regarding the fate of legislation such as the 2017 Tax Cuts and Jobs Act.

The following sections discuss our views on five common election-related narratives in the marketplace today. Specifically, we discuss how:

• Stock market volatility may rise as the election approaches and policy uncertainty grows but historically settles down post event.
• Discounted relative valuations and a rebound in earnings growth for some companies are more likely to spark a rotation in equity style factors than politics.
• Regardless of the election result and despite elevated deficits, we expect fading inflation and slowing growth will be good for bond investors.
• A “red wave” should temporarily boost the US dollar but eventually stretched valuations and the Fed following its global peers with rate cuts will lead to the currency’s decline.
• On climate, a Harris win will mean more investment, while a Trump win may mean some regulations are rolled back; however, legislation like the Inflation Reduction Act (IRA) will be difficult to roll back, given its established law and broadly distributed benefits.

A common thread of the sections is that we believe that the macro environment and valuations will be larger drivers of investment outcomes than the election. This is not to say that certain election outcomes don’t create some specific winners and losers; for example, smaller companies could benefit more from tax cuts under a red wave. Nor is it to argue that sequencing doesn’t matter—markets may remain volatile after the election if new policies that are negative for markets (e.g., tariffs) are implemented before other positives (e.g., corporate tax cuts). Still, given that market focus eventually returns to fundamentals, and everything that is promised by politicians is not always delivered, we do not recommend making asset allocation changes due to perceived election outcomes.

Market Narrative #1: Volatility Will Be Elevated Around the Election

We agree with this marketplace narrative. The CBOE Volatility Index (VIX), which is a measure of expected short-term equity volatility, has tended to increase in the months leading up to US presidential elections, with a notable increase approximately two months before election day. This rise in volatility is due to investor unease about potential policy changes and media amplification of political events. However, this heightened volatility usually subsides immediately after the election, as the resolution of uncertainty allows investors to assess the new administration’s impact on capital markets.

For much of 2024, the VIX traded at very low levels, averaging less than 14 from January through July, well below its long-term average of 19.5. However, October VIX futures indicate that investors have expected higher volatility near the election, as these futures have been priced around 13% higher than September futures since they started trading in January.

Recently, the VIX spiked due to concerns about US economic weakness and unknown risks linked to an unwinding of the yen carry trade. Broader economic issues like these often drive market volatility more than election concerns. For example, the 2008 Global Financial Crisis intensified about a month before the presidential election, overshadowing election jitters.

Investors should expect volatility around the US presidential election to remain high relative to this year’s typical level. While there can be other catalysts that drive stock market turbulence to a greater degree than politics, it is worth remembering that equity markets are often in better shape just one year after the election. In fact, since 1980, there has only been one election year where the S&P 500 was lower 12 months after the election—2000, amid the implosion of the dot-com bubble.

Market Narrative #2: The US Election Result Will Trigger an Equity Style Rotation

We disagree with this marketplace narrative. We don’t think the US election results will be the main driver of a major equity market rotation. Instead, we believe that valuations, fundamentals, and the changing macro environment are more likely to drive relative performance.

Recent months have seen signs of slowing economic growth, ebbing inflation, and a nascent rotation in the US equity market. Previous winners, such as large-cap growth stocks, have underperformed, given concerns over valuations and payoffs for AI-related investment, while simultaneous growing expectations of future Fed easing have boosted demand for previous laggards like small-cap equities and value stocks.

At first blush, certain aspects of the economic platforms of the main candidates could be viewed as accelerating these macro changes and thus quickening this rotation. For example, Democratic pledges to extend most household tax cuts could boost revenues for more cyclical value stocks, while Republican promises to further reduce corporate tax rates could boost margins of small US companies, which have higher effective tax rates. In the same vein, Republican promises of lighter regulatory oversight could boost value sectors such as energy and financials.

But history cautions against simplified narratives and ignoring fundamentals or valuations. Recall, for example, that despite similar pledges around eight years ago, the first Trump presidency saw energy stocks underperform. Conversely, these (oversold) energy companies rebounded, while (expensive) clean energy stocks lagged during the Biden administration despite passage of the IRA. More broadly, given many Russell 2000® companies are unprofitable, it is not clear how much they would benefit from further reduction in corporate tax rates.

Looking ahead, we think a rotation toward high-quality US small-cap companies and value stocks is more likely to be driven by deeply discounted relative valuations and a rebound in earnings growth as opposed to being weighted on a particular political outcome. Small caps in particular are expected to post weaker earnings growth in 2024, but a lower base means profit growth should recover under most potential economic and political outcomes next year. Expected rate cuts will help by lowering debt servicing costs. While potential election outcomes could influence regulations and legislation that benefit some sectors more than others, absent a crystal ball we continue to rely instead on time-tested valuations and fundamentals.

Market Narrative #3: One Party Sweeping the Election Will Be Bearish for US Treasury Securities

We disagree with this marketplace narrative. While a unified government ¹ might lead to slightly larger deficits, it does not change our view that the US economic cycle will likely support US Treasury performance over the next one to two years. Consequently, we do not recommend reducing allocations to high-quality US bonds, and we still see value in maintaining duration at a total portfolio level.

The belief that a unified government will be bearish for US Treasury securities assumes this outcome will lead to greater fiscal expansion, increased Treasury supply, and higher yields. Similar concerns led to ten-year Treasury yields surging nearly 100 basis points after the 2016 election. More recently, concerns about deteriorating public finances in developed markets have added to bond market volatility. However, studies show that the historical relationship between government debt and yields is relatively weak. Yields tend to be more sensitive to economic fundamentals and changes in monetary policy expectations. Additionally, the poor US fiscal outlook is well-known, and the CBO’s latest projections suggest the election outcome will have a limited impact on the current trajectory of US public finances.

Tariffs are another concern, with former President Trump proposing a 10% tariff on all imports into the United States. Estimates suggest this would increase annual core inflation by around 1 percentage point. ² However, this is a one-time price boost that will drop out of the annual figures after one year. In theory, the Fed should look through the price impact of tariffs, especially if it is weighing them against a continued cooling in the labor market, as we expect.

While the election could contribute to increased bond volatility and higher interest rates in the short term, it is important to remember that the election does not happen in a vacuum. Over the course of a full presidential term, we would expect the underlying economic cycle to be the more important driver of Treasury yields. In that regard, we expect continued moderation in US inflation, cooling in the labor market, and the Fed embarking on an easing cycle to support US Treasury securities.

Market Narrative #4: A Red Wave Will Strengthen the Dollar

We agree that a Republican sweep could initially strengthen the dollar. Implementation of the Trump administration’s proposed policies, including the imposition of tariffs on imports and a sweeping reduction in immigration, would provide support to the dollar. A Republican-controlled Congress delivering looser fiscal policy ³ would also serve as a bolster. However, we believe this boost would likely prove transient, with the broader cyclical backdrop being the more significant driver and auguring for a longer-term decline.

Both economic theory and the precedent of the prior Trump administration suggest that the imposition of trade tariffs would tend to strengthen the dollar. In the first instance, there is a competitiveness adjustment in the currencies of impacted markets, as a new competitive equilibrium is found. This process would tend to support the dollar versus its peers, at least initially, due to the less trade-dependent nature of the US economy. Additionally, while a tariff-driven price rise should be a one-off, market interest rates could still move higher in response, particularly given the context of recent elevated inflation. Limiting immigration could also impact interest rates by capping the supply of labor, which would benefit the dollar. A Republican sweep of Congress—which is not currently expected—could be more growth supportive in the short run than the counterfactual, potentially bolstering the dollar as expectations adjust.

However, we expect the underlying cyclical backdrop to be the more important driver of the currency over the course of a full presidential term. In this regard, and with the dollar still richly valued, more balanced global growth and the Fed following its peers into a rate-cutting cycle should see the dollar decline. Additionally, cutting immigration reduces potential growth, while tariffs essentially function as a tax on the consumer and should eventually weigh on growth and inflation if not offset in some way. Though a unified Republican Congress is likely to deliver some offsets, they are unlikely to have the type of durable impact on growth that may be needed to support the dollar more structurally. Finally, Trump has spoken often about his concerns over the strength of the dollar and his desire to revive domestic manufacturing via a weaker currency. Explicit intervention to weaken the dollar looks unlikely, but jawboning could eventually have some impact when it aligns with the direction justified by fundamentals.

Market Narrative #5: A Harris Presidency Will Permit Greater Climate Investment

We agree with this marketplace narrative. Kamala Harris is expected to continue implementing the IRA, with a substantial portion of its funding still available for climate investment. She may have the opportunity to expand climate initiatives if Democrats secure majorities in both chambers of Congress.

The Biden administration has championed climate-friendly initiatives, including rejoining the Paris Agreement and passing the IRA, which represents the largest investment in addressing climate change in US history. As vice president, Harris was closely involved in the rollout of the IRA, and her continuation of this policy will likely be a top priority for her administration. The IRA is expected to accelerate decarbonization; models project that it could contribute to an average 37% reduction in US greenhouse gas emissions by 2030 compared to 2005 levels. ⁴ However, these initiatives may fall short of the US commitment to cut emissions by 50% by 2030 compared to 2005 levels.

Harris may not just continue President Biden’s climate policies but could seek to expand them if the opportunity arises. For example, Democrats have hinted at a desire to expand clean energy tax credits beyond what has already been established in the IRA. Harris’s ability to drive a more ambitious climate policy will depend on the balance of power in Congress, as significant changes to climate legislation would require approval by both the House of Representatives and the Senate.

By comparison, a Trump presidency would focus on scaling back renewable energy policy. With a second term, Trump could be more effective in repealing some climate-related regulations due to more experienced staff and a judiciary that may be more favorable to deregulation efforts. However, Trump’s ability to fully reverse climate investment trends is limited. Significant climate and energy investments, such as those in the IRA and the Infrastructure Investment and Jobs Act, are established by law and would be difficult to repeal. These laws have bipartisan support, especially in areas benefiting from the investments. Furthermore, the broad trend toward clean energy and decarbonization is driven by market forces and technological advancements, which are likely to continue regardless of political changes.

Navigating Narratives, and Staying the Course

Looking ahead, investors should remain focused on long-term drivers of asset prices rather than getting swayed by political noise. While we expect higher volatility near the election, it should subside once the immediate uncertainties are resolved. Certain asset classes may come under more pressure in some election outcomes, given the potential policy implications. For example, higher tariffs are likely a near-term headwind for US Treasury securities and non-US stocks, all else equal. Still, even in these instances, we expect other factors—such as the current macro environment, fundamentals, and valuations—will likely outweigh any policy-related impact on asset prices over the course of a full presidential term.

As such, we do not believe investors should position portfolios in response to any one election outcome. Instead, we believe investors are best served by relying on a well-constructed asset allocation, sticking to any predetermined rebalancing policy, and monitoring liquidity sources and needs to navigate and potentially take advantage of any dislocations in asset prices around the election.

Sean Duffin, Senior Investment Director, Capital Markets Research
Wade O’Brien, Managing Director, Capital Markets Research
Thomas O’Mahony, Senior Investment Director, Capital Markets Research
TJ Scavone, Senior Investment Director, Capital Markets Research

Other contributors to this publication include Drew Boyer and Graham Landrith.

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

The post US Election Anxiety: Keeping Calm Amid Political Uncertainty appeared first on Cambridge Associates.

In this edition of VantagePoint, we find that consumers, corporations, and the banking sector remain in good shape, and while US/global economic growth is likely to slow in the second half of 2024 relative to the first, we expect it will remain positive. Although market concentration risk is elevated, given its focus on highly profitable AI-related tech stocks, we would seek to be measured about diversifying such risks. We recommend modest, risk-controlled tilts away from mega-cap tech stocks toward more attractive developed markets small-cap and value stocks. We review the importance of consistent risk management practices including diversification and liquidity management. Fortunately, there are attractive investments that can provide portfolio resilience and be additive to long-term performance. Further, liquidity management can help investors maintain their strategic direction in the face of equity market downturns by providing confidence in the ability to meet cash needs for spending, taxes, rebalancing, and capital calls.

Keeping Track of the Plot

Markets have been laser focused on economic data, creating volatility around data releases. Leveraged and crowded positions have been particularly vulnerable, especially as the unwinding of the Japanese yen carry trade led to deleveraging and general de-risking.

Change has been afoot since the surprisingly soft July 11 US Consumer Price Index report sparked a market rotation. As Treasury yields fell amid rising expectations of US central bank easing and a soft landing, unloved small-cap stocks and global value stocks outperformed the AI darlings that had dominated the market. US small-cap stocks were also boosted by rising expectations for a Trump presidency and a Republican sweep of Congress prior to President Biden pulling out of the race.

The tide shifted again on August 2 after a weak US labor report renewed recession expectations. The Japanese yen carry trade unwound as the yen spiked, supported by tighter interest rate differentials between US Treasuries and Japanese government bonds that had already begun narrowing after a Bank of Japan (BOJ) rate hike in late July. As equities broadly sold off, mega-cap tech stocks did not resume their leadership. For the first five days of August, both the Magnificent 7 (Mag 7) and US small caps underperformed equities outside the United States, while Japanese equities suffered disproportionately. US Treasury yields proved defensive, with the ten-year yield falling more than 20 basis points during the depths of the equity sell-off.

Equity markets have largely returned to previous levels, although mega-cap tech stocks and Japanese equities remain below recent high-water marks. The recovery was helped along as BOJ officials sought to settle markets by signaling a gradual approach to monetary policy tightening that is sensitive to volatility, and firmer US data releases also supported markets.

Slowing Inflation and Softening Economic Data

Global economic data have been holding up well this year as inflation has continued to decelerate, although there have been some signs of softening, particularly in China and Europe. Data for the United States have been mixed, but reflective of a slowing economy, not a recession. Recent concerns have focused on the labor market, where the unemployment rate has gradually increased, jobless claims have risen, and job growth has decelerated. Labor market conditions are consistent with an expanding economy, but the rate of change has caused concerns that further deterioration is on the horizon. The Sahm rule has been triggered at a 0.5-percentage point increase in the three-month average unemployment rate from its recent low. This has historically led to a substantial rise in unemployment and eventually a recession. Much of the recent rise in unemployment has been due to increased labor force participation rather than layoffs, putting the utility of the measure in question.

Still, slightly softer growth and a more mixed economic outlook suggest recession risks have risen, as confirmed by consensus expectations. There has also been some deterioration in the weakest segments of the economy, as reflected in the rise in defaults rates on credit cards and non–investment-grade debt.

The Fed has considerable flexibility to address economic weaknesses should a recession develop, with the Fed funds rate target between 5.25% and 5.5%—the highest in 22 years. Furthermore, US households and corporations are in a better position today than they have been heading into previous slowdowns, which should help support growth. For example, the vast majority of US households and investment-grade, non-financial corporations are healthy with reasonable interest coverage. Banks are also better capitalized following increased regulatory requirements, particularly for large, systemically important banks. This could certainly change with a sharp increase in unemployment, but this is not our base case.

Market Concentration and the Magnificent 7

The second major market narrative that has been shifting is the faith in the Mag 7 stocks. This group of stocks is central to the broad market’s performance as it accounts for about 20% of global equities and 30% of the S&P 500 market capitalization. This transformation has been driven by exceptionally strong relative performance. Over the last 15 years, US equities have accounted for 58% of developed markets equity returns, with roughly half of the US return attributable to the tech and interactive media sectors, according to analysis by Empirical Research Partners.

In recent years, returns have been driven by tech stocks’ relative earnings strength, particularly Nvidia and most of the Mag 7. In fact, if you exclude the Mag 7, earnings growth for US stocks have lagged that of other developed markets, although US stocks are expected to catch up again in the next year or two. While earnings growth for the Mag 7 has been exceptional, the scale of capex and research and development (R&D) spending by these firms on AI initiatives have raised doubts about the ability of AI applications to deliver a return on investment that can support continued elevated earnings growth.

Investors are right to be concerned. Disruptive innovation cycles create vast opportunities, the scope and timing of which are difficult to estimate. During the technology and telecommunications boom, real capital expenditures increased at a rate of 12% per year from 1991 to 2000. As much as 95% of installed fiber-optic cable remained unused immediately following the bursting of the technology, media, and telecom (TMT) bubble, which forced overleveraged telecommunications out of business. AI spending has been significant, with Mag 7 capex and R&D spending totaling $419 billion in 2023, accounting for about 20% of S&P 500 capex and 40% of reported R&D with more expected in the next few years.

However, there are important differences between the TMT bubble and the current buildout of AI. In contrast to the overleveraged telecommunications firms of the TMT bust, most of the Mag 7 benefits from high free cash flow margins and squeaky-clean balance sheets. At the height of the tech bubble, TMT stocks were spending more than 100% of operating cash flows on capex and R&D. In contrast, today’s mega-cap tech companies’ capex and R&D as a share of cash from operations is 72%, close to the 40-year median of 67%. Should development of profitable applications using AI disappoint, high valuations will not be sustained. However, investors are not taking a solvency risk, but rather a concentrated risk, which can be managed. Given the strength of these companies and their promising prospects, we would tightly manage underweights, tilting modestly into more attractively valued segments of the market.

A Plethora of Additional Risks

There is no shortage of risks for investors to consider. For example, commercial property markets, particularly office, present opportunities for stress that will intensify should interest rates remain elevated or increase from current levels. High sovereign debt as a share of GDP presents another challenge. Episodes of market stress related to sovereign debt largesse were briefly experienced in the UK gilt market during Liz Truss’s brief stint as prime minister and in the French OAT market around the French parliamentary election. US debt is also elevated; however, as the reserve currency, the United States benefits from steady demand associated with global trade and lending, with no apparent competitor at the ready to displace the US dollar. Volatility tied to disruptive secular forces like AI transformations, climate change and energy transition, shifting supply chains, inflation, and broader geopolitical and political strains also pose risks. These risks will likewise bring opportunities for investors that closely study the shifting landscape and partner with asset managers that bring diverse perspectives that can help identify varied opportunities in a changing and dynamic landscape.

Key Components of Risk Management

While economic conditions appear solid, economic growth has slowed and default rates on weak credits have increased even as they remain low. The severity of the yen carry trade unwinding—while brief—highlights that risks can accumulate in the system and manifest unpredictably. The foundation of a successful investment strategy is careful portfolio construction and liquidity risk management, not rash reactions to market volatility.

Layer Diversification

Well-constructed portfolios are designed to meet long-term and near-term return objectives, while maintaining adequate diversification and liquidity sources to manage through challenging downturns. Too much diversification into ultra-safe assets, and portfolio return objectives may not be met, while too little could result in permanent loss of capital if a meaningful share of risky assets must be sold at depressed prices to meet spending needs.

The most reliable and efficient form of portfolio diversification is high-quality bonds, particularly US Treasury yields. Given these diversification characteristics and reasonable valuations at current yields, we recommend maintaining a neutral exposure to Treasury yields relative to policy targets. Cash can also provide more stability, but generally at a high opportunity cost. Holding cash has been additive to portfolios as the yield curve has been inverted, but low long-term return expectations and the lack of upside potential during periods of stress make longer-duration Treasury yields a more useful diversifier.

Inflation-linked sovereign bonds (ILBs) provide an interesting supplement to nominal sovereign bonds today, given still-elevated real yields and their ability to serve as a viable hedge against inflation, while also contributing to portfolio resilience in a variety of economic outcomes. ILBs are less volatile and higher returning than most inflation-sensitive assets, but they are less liquid than nominal sovereign bonds and have faced pressure during previous periods of stress. Similarly, global macro hedge funds and trend-following strategies can be useful diversifiers as a second layer of defense in portfolios. Such strategies have the potential to be long volatility when equities are under stress, while trend following can also provide diversification against varied risks, especially for strategies that cover a variety of markets. These strategies are less reliable than high-quality sovereign bonds and require thoughtful manager selection and portfolio construction but are worth the effort in building resilient diversification.

Embrace Optionality

One component of diversification we like today are strategies that offer optionality—good return prospects across the economic cycle with potential to outperform during periods of stress or distress. Equity long/short (ELS) is one such example. ELS hedge funds have increased in appeal in the last year but have seen dwindling portfolio allocations among investors. As we noted in our 2024 Outlook, the lifting of some structural factors that have held ELS hedge funds back since the Global Financial Crisis (GFC)—low interest rates, muted volatility, and exceptional long-only equity returns—have faded. Most notably, the short rebate exceeds dividend yields by the widest margin since 2001, marking a more favorable environment for short sellers. Further, our expectations that weaker economic growth will lead to more dispersion in corporate fundamentals, while secular shifts related to supply-chain adjustments and technological innovation create opportunities for highly skilled managers to add value on the long and short sides of their books, providing diversification to portfolios and adding alpha.

A variety of uncorrelated strategies (e.g., insurance-related strategies) can offer helpful diversification by taking a range of risks less dependent on economic growth. The key challenges with these investments are the steep learning curve required for due diligence and their tendency to be somewhat illiquid. Even seemingly liquid strategies—like many absolute return–oriented hedge funds—chose to gate investors from accessing funds during the stress that followed the GFC. These strategies often need to be thought of as providing long-term diversification rather than as a source of liquidity to tap during times of stress.

Diversify Some Equity Concentration Risk

As noted above, global equities have become increasingly concentrated, making diversification within equities an important part of risk management. The concentration and level of valuation warrants tilting away from these names. Yet, the strength and growth prospects of these companies drives us to do so in a tightly risk-managed fashion. Many portfolios already have sufficient underweights relative to market benchmarks given the use of active managers. Active managers tend to both differentiate bets within Mag 7 names and hold more equal-weighted portfolios. While non-US equities offer cheaper valuations than US equities, US equity valuations are less elevated once we exclude the Mag 7. We expect tilting toward value and small caps in developed markets will add more value to portfolios than overweighting non-US developed markets. Within small caps, we focus on higher quality, particularly in the US market where a greater share of small caps has no—or negative—earnings.

Dynamic Liquidity Management

A critical dimension of risk management is provisioning for cash sources during times of stress to meet spending, tax, capital calls, or rebalancing needs. Portfolios have become less liquid as investors shifted from traditional stocks and bonds to private investments. Endowments with more than $500 million now hold 34% in private investments, up from 23% a decade ago, with uncalled capital commitments equal to 16% of portfolio market value. Larger private equity allocations can enhance returns but also increase illiquidity risks in downturns.

Not only have allocations to illiquid assets increased, but the liquidity of such assets has diminished. For example, the number of years until global venture capital investors receive distributions equal to invested capital has increased from the eight to nine years experienced in 2010–14. On average, global venture capital funds of vintage year 2015 and beyond have not yet reached this milestone. A stagnant IPO market and the preference of many private companies to stay private for longer perpetuate this trend, although the rapid growth of continuation vehicles and the deepening secondary market offer increasing exit opportunities. These shifts necessitate increased liquidity planning, especially for institutions with significant annual spending needs and investments with lock-ups. A slower distribution pace also requires a slowing of commitment pace needed to meet or maintain policy target allocations and the ability for private investment programs to be self-financing.

To properly provision for liquidity needs, investors need to consider three dimensions of liquidity that can shift in times of stress: 1) portfolio liquidity; 2) access to liquidity outside the portfolio from reserves, debt capacity, charitable donations, revenue, or earnings; and 3) spending needs. During market downturns, portfolio asset liquidity diminishes as funds with gating provisions will lower gates, private investments make distributions more slowly relative to the pace of capital calls, and bid-ask spreads of less liquid markets widen, requiring larger discounts to transact. Downturns can have systemic impacts, affecting bond issuers’ credit ratings and increasing borrowing costs. Institutions relying on charitable giving or cyclical revenues may see contributions drop during downturns, just when spending needs rise. Colleges and universities already facing demographic challenges can see their revenues further pressured. Potential changes in tax circumstances should also be considered. Spending needs from long-term assets can increase, especially if other revenue/income sources decline, and at a minimum are likely to remain constant in terms of absolute amounts such that spending represents a higher share of asset values.

Investors with significant allocations to illiquid funds should stress test their portfolios and develop a plan for sourcing and using available liquidity during the next downturn. Our primer on liquidity management can provide a helpful guide to liquidity stress testing.

Conclusion

While economic growth is slowing, the fundamentals of consumers, corporations, and the banking sector remain robust. Recent market volatility underscores the importance of adhering to a well-constructed asset allocation, consistent risk management practices, and vigilant liquidity management. We would maintain strategic exposures to equities while reviewing equity concentration risk, the construction of diversifying assets, and liquidity sources and uses to make sure they are fit for purpose in the current environment.

We would modestly diversify concentration risk in equity markets as AI-related tech stocks offer secular appeal but are richly valued. Using active managers will naturally provide some diversification. Our tactical tilts to more attractively valued developed markets small-cap and value stocks can provide further diversification. As yields have settled at higher levels than we have seen in recent years, a wider range of diverse exposures have become more attractive. High-quality nominal sovereign bonds and ILBs, trend following, and global macro hedge funds offer valuable diversification. Additionally, strategies that provide optionality—such as ELS and less economically sensitive strategies—can enhance portfolio resilience.

Dynamic liquidity management is crucial, especially for investors with significant allocations to private investments. While the current market environment presents numerous challenges, it also offers opportunities for those who are prepared. By focusing on diversification that includes value added opportunities, liquidity management, and strategic asset allocation, investors can build resilient portfolios capable of weathering economic storms and achieving long-term success.

Celia Dallas, Chief Investment Strategist

Grayson Kirk and Ilona Vdovina also contributed to this publication.

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.

The post VantagePoint: As the Narratives Turn appeared first on Cambridge Associates.

Chinese equities have suffered over the past three years, given concerns over geopolitics and China’s economy. Despite several short-lived rallies, the MSCI China All Shares Index remains down almost 50% from its February 2021 peak in US dollar terms. ⁵ Fundamentally, for a sustained rally, China needs a rebound in domestic confidence and demand, particularly for the hard-hit real estate and consumer sectors. Although China has taken measures to contain financial risks in its property market, the government’s focus on controlling debt risks imply officials have been cautious in deploying large-scale stimulus to boost growth. Further, policy guidance following the Third Plenum re-emphasized “high-quality” growth as China seeks to build out its strategic industrial and technological sectors (green energy, advanced manufacturing, etc.), and suggests no urgency to tackle current depressed sentiments.

Meanwhile, weaker economic activity in China is translating to deflationary pressures, with July headline inflation only 0.5% year-over-year (YOY), while the GDP deflator was -0.7% YOY in the second quarter. Thus, while nominal interest rates in China appear low, real or inflation-adjusted rates have been high and restrictive on growth.

However, the desire for a stable RMB has limited the PBOC’s ability to ease monetary policy more aggressively. On the contrary, beginning in July, the central bank has taken measures to place a floor on Chinese government bond yields to support the currency, effectively tightening monetary policy. Impending Fed rate cuts may eventually ease pressure on the RMB, but uncertainty over the timing and magnitude of the PBOC’s response remains.

Weaker growth and inflation have impacted Chinese corporate earnings, although the declines seen in trailing earnings and return on equity (ROE) have bottomed out. Analysts’ expectations for Chinese corporate earnings growth in 2024 and 2025 have been revised down but remain healthy at 14.4% and 11.8%, respectively, versus estimates for global equities at 9.8% and 13.6%.

Current valuations for Chinese equities remain very low, especially relative to global equities. As of July, the MSCI China All Shares Index traded at around 10x earnings across the forward price-earnings (P/E), ROE-adjusted P/E, and normalized price–cash earnings ratios. A composite of these metrics is at the 14th percentile relative to history, while valuations relative to global equities have rarely been cheaper. Depressed equity valuations suggest negative sentiments and risks are largely priced in, thus offering significant upside potential should China’s growth outlook improve.

Overall, Chinese corporate fundamentals have stabilized, and equity valuations are attractively priced for significant upside gains. However, unlocking this value requires a rebound in China’s domestic sentiments and demand, which will take time absent additional policy support. The same was the case for Japanese equities during the 1990s and early 2000s; the market would meaningfully outperform global equities when government stimulus triggered growth rebounds in the absence of domestic demand. While China’s caution in deploying more aggressive stimulus is largely tied to its policy priorities, there are also views that the government may be saving firepower until after the US elections to adequately respond to any new policy actions (e.g., increased tariffs on Chinese exports to the United States). Yet, US policies toward China will not be clear until well after the election results and a new Congress takes over in early 2025. Given the uncertainties surrounding China, we recommend that investors be neutral on a tactical basis.

Aaron Costello, Head of Asia

Vivian Gan, Associate Investment Director, Capital Markets Research

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. Based on daily total net return data as of August 23, 2024.

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EM versus developed markets (DM) performance cycles are highly cyclical by nature. Over the past nearly 15 years in the post-GFC era, EM equities lagged DM by a staggering 8 percentage points (ppts) per year. A strengthening US dollar, relatively weak EM earnings, and US equity dominance were the primary detractors over this period. However, EM did manage to outperform the DM ex US bloc between 2017 and 2021, highlighting the recent outsized influence of US stocks. EM underperformed broader DM by a similar magnitude in the mid to late 1990s but has also shown the ability to outperform. During the cycle that started in 1999, EM outgained broad DM by a whopping 13 ppts annualized over a nearly 12-year period. Risk-adjusted performance has also been superior to that of DM during relative performance upcycles, despite the higher volatility of EM equities.

Performance cycles tend to be catalyzed by shifts in the macroeconomic backdrop. Just as many investors were wrongfooted by the return of inflation and high interest rates in early 2022, shifting macro conditions can trigger sharp equity market rotations seemingly without warning. A scenario where macroeconomic conditions once again favor EM stocks is not farfetched today. The US dollar’s valuation currently sits at top-decile levels, while economists anticipate a widening in the EM/DM economic growth differential. Coupled with expectations for Federal Reserve rate cuts as early as next month, the potential for a sustained period of US dollar weakening has increased, which would prove a tailwind for EM equities. Finally, the US economy is likely in a late expansion or slowdown phase of the business cycle, where EM’s best performance vis-à-vis DM typically occurs during the following early/recovery stage of the cycle.

Won’t DM equity allocations provide ample exposure to the EM bloc, given the globally diversified revenue base of many DM stocks? This is one argument that has been offered to avoid allocating to EM. However, it does not hold water. According to FactSet, only 23% of DM company revenues are generated in emerging and frontier markets, where China alone accounts for nearly one-third of that total. In contrast, more than 70% of EM company revenues are derived from emerging and frontier markets, suggesting that EM allocations are the best way to achieve true exposure to EM. Further, EM equities themselves are fertile ground for active managers to add value.

Right now, EM equities also help reduce exposure to richly priced US equities. Global equity benchmarks are more exposed than ever to US stocks, which account for a record 65% of global equity market cap. And said exposure does not come cheap. The US market currently trades at more than 21x 12-month forward earnings. By contrast, EM equities trade at a forward price-earnings ratio of just 12x, reflecting a near-record valuation discount. While such a valuation disparity itself does not warrant an overweight stance to EM, investors should continue holding EM stocks as valuations tend to be more meaningful over longer-term periods. Further, we question whether US equity exceptionalism can be sustained, given today’s high earnings per share growth expectations, lofty valuations, and profit margin sustainability concerns.

EM equities may benefit from nascent structural trends over the longer term. These include US/China decoupling, nearshoring, technological innovation and adoption (including digitalization, fintech, and artificial intelligence), and growth of the middle-class consumer. These factors have already been reflected in recent equity returns and a shifting EM index composition. India (14.6%), Mexico (7.3%), and Taiwan (7.2%) have all outperformed DM equities (6.8%) over the prior three years, while China’s weight is down nearly 20 ppts, from a peak of 43% in 2020 to just 25% today. ASEAN countries have already started to benefit economically from shifting supply chains, and we expect that potential for increased foreign capital flows will create tailwinds for these equity markets over time.

Investors tempted to abandon EM equities altogether would be wise not to extrapolate the recent past into the future, as they may yet benefit from EM equity allocations at subsequent turns in the cycle. In the meantime, EM equities offer a wide opportunity set for skilled active managers to add value. We remain neutral on EM equity allocations today and recommend investors hold these allocations in line with their weight in global equity indexes, having recently closed an overweight recommendation to Chinese stocks.

Stuart Brown, Investment Director, Capital Markets Research

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. Based on daily total net return data as of August 23, 2024.

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Japanese markets have been the most eye-catching in this current bout of turbulence. After the yen reached an all-time low of nearly ¥162 to the dollar in early July, it has since strengthened by 12.6%. A compression in interest rate differentials, driven by both soft US economic data and hawkish Bank of Japan decisions, contributed to the large yen appreciation. This move caused many so-called carry trades—which relied on a weak yen to fund positions in high-yielding assets—to unwind. In addition, Japanese equities had been a very popular macro trade, leaving it exposed to a large deleveraging event. This is evident in the 20.3% decline in the Tokyo Price Index (TOPIX) over the last three trading days.

Other equity regions have sold off as well, although to a significantly lesser extent. Most meaningful for portfolios is the United States, due to its sheer size, connections to the carry trade, and concerns about its economy. The economic anxieties have most recently been centered on the labor market, where the unemployment rate has steadily risen, as have jobless claims, while job growth has slowed. While most, if not all, of these metrics are at otherwise normal values from a level perspective, the concern is that they may continue to deteriorate. For example, the Sahm rule, which was recently triggered, highlights that a 0.5-percentage point rise in the three-month average unemployment rate from its recent low has always led to a further material rise in unemployment and, ultimately, recession. This is a statistical regularity with a small sample size and not a law of nature. So, it is possible that the unique context of this economic cycle will disrupt that relationship. Indeed, most of the rise in unemployment has been driven by an increase in labor force participation, not layoffs, and the US economy grew by 2.8% in the second quarter and July’s composite Purchasing Managers’ Index points to continued growth for the month. Still, the Federal Reserve has ample room to respond to economic weakness, with futures markets increasing their expectations in recent days from three 25-basis point cuts by the end of 2024 to five.

In addition to economic data, US equities have also been impacted by second quarter earnings results. The central role that earnings expectations for tech stocks have played in this year’s rally meant that this season’s “Magnificent 7” results were closely scrutinized. While headline revenue and earnings results were generally solid-to-good, the market nonetheless took fright at the scale of the capital expenditures that these firms remain committed to making to achieve their AI-related objectives. The elevated valuations of some firms left them exposed to any reappraisal of the transformative effect of AI initiatives on their future earnings. As a result, the tech-heavy Nasdaq Composite was down 13.3% below its recent peak during trading today, while the broader S&P 500 Index was down 8.6%.

Given the equity sell-off, the temptation may be to cut equity risk to avoid additional losses. But we view all bets through the lens of probability, and cutting equity allocations for, say cash or bonds, has not been a high probability bet historically, even in periods of high volatility. By shifting meaningfully from stocks into cash or bonds, investors could also concentrate value added performance into one decision, overwhelming all other sources of value add, such as those linked to individual managers. Last, and relatedly, when markets move violently in one direction, they tend to correct violently in the other direction. So, cutting equity risk now could lock in large losses relative to policy that could weigh on portfolios for years.

Instead, we believe investors are best served by relying on a well-constructed asset allocation, sticking to any pre-determined rebalancing policy, and monitoring liquidity sources and needs. We continue to favor modest overweights in developed markets value and small-cap equities, both of which have compelling valuations and earnings outlooks with more upside potential relative to broad equity markets. We also believe investors should continue to hold high-quality defensive assets, such as long US Treasury securities. While long Treasury securities are less attractive today than a week ago, given the large drop in yields, we continue to see value in holding an overweight position in the next weeks given the potential for economic weakness and market volatility.

Stepping back though, chaotic periods always remind us of a key maxim—thoughtful decisions, not rash actions, are what separate top-performing investors from everyone else.

Kevin Rosenbaum
Head of Global Capital Markets Research

Thomas O’Mahony
Senior Investment Director, Capital Markets Research

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. Based on daily total net return data as of August 23, 2024.

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Real interest rates have increased substantially in recent years, making real yields offered by global inflation-linked bonds, particularly US TIPS, more attractive than they have been in a long time. The Bloomberg US TIPS Index had a real yield of 2.0% as of July 17, which has slightly decreased from its recent peak but is still over 300 basis points above its all-time low set in 2021. This is a substantial move. Consequently, real yields in the United States have approached the 65th percentile of their historical distribution, which ranks best among global peers. Additionally, ten-year real yields in the United States surpass the yield implied by the trend growth rate of the economy (a proxy of their fair value) by nearly 1 standard deviation—another indication that real yields are elevated.

With the rise in real interest rates, investors can once again consider inflation-linked bonds a viable inflation hedge. These bonds pay a real return plus inflation over their life, making them appealing for buy-and-hold investors with significant exposure to real liabilities. Their value diminished when real yields neared zero or turned negative and inflation remained muted, as was the case for much of the previous decade. Today, however, both real yields and inflation have risen, making the math for inflation-linked bond returns more favorable. At a minimum, inflation-linked bonds should return around 2% at maturity, assuming inflation is 0%, but they should return between 4% and 5% if the markets’ expectations about inflation averaging slightly above 2% prove correct, and possibly 5% to 6% if inflation exceeds expectations.

In addition to compensating investors for inflation over time, inflation-linked bonds should perform well in another inflation shock. According to our scenario-based return projections, commodities and inflation-linked bonds are the only two major asset classes we expect to have positive annual real returns in a scenario modeled on an inflationary environment like the 1970s, with 7% average inflation over the next three years. Unlike most other inflation-sensitive assets, inflation-linked bonds typically offer a real yield and lower volatility. They are also resilient in various economic scenarios, including typical deflationary shocks associated with most recessions. Because of these unique characteristics, inflation-linked bonds may provide more broad-based portfolio diversification benefits and superior long-run returns than other inflation-sensitive assets, such as commodities, in both nominal and risk-adjusted terms.

While there is a lot to like about inflation-linked bonds, they do have shortcomings. They tend to underperform other high-quality bonds, such as nominal Treasury bonds, over short periods when inflation falls and over time when realized inflation is below expected inflation. They also exhibit less liquidity and have faced pressure during previous periods of stress, such as in March 2020. Additionally, inflation-linked bonds are sensitive to rising real interest rates, which can partially offset their inflation benefit over short periods. This sensitivity led to their unsatisfying performance during the recent bout of inflation. However, higher starting real yields make this less of a headwind today. Based on our modeling, US TIPS would return 2.6% per annum over the next three years in a stylized scenario based on a repeat of the 2021–23 inflation shock—a marked improvement from the actual -1.3% per annum return they achieved from 2021 to 2023. Performance would be even better if the rise in real yields is less pronounced, given that they are not as depressed as they were previously. We would still expect inflation-linked bonds to underperform other inflation-sensitive assets in this scenario, as they tend to have a lower beta to inflation. Still, even though investors may not get the most bang for their buck in an inflation shock with inflation-linked bonds, they can feel confident that these bonds once again provided a reliable hedge against inflation and have outperformed other inflation-sensitive assets, usually with less volatility, in the long run.

Given their attractive real yields and unique characteristics, investors should consider inflation-linked bonds a valuable component for portfolio diversification in today’s uncertain economic environment. For buy-and-hold investors with significant exposure to real liabilities, these bonds provide a reliable hedge against inflation and have historically outperformed other inflation-sensitive assets with less volatility over the long term. In an era of heightened economic uncertainty, where inflation poses a potential risk, including inflation-linked bonds can enhance portfolio resilience and provide peace of mind.

TJ Scavone, Senior Investment Director, Capital Markets Research

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. Based on daily total net return data as of August 23, 2024.

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While the Labour Party have been given a mandate to govern, it is less obvious that they have been granted a mandate for substantial fiscal change, given the cautious manifesto upon which they campaigned. For instance, Labour has committed to two budgetary rules: (1) debt-to-GDP should fall by the fifth year of budgetary forecasts; and (2) the current budget should be in balance on the same time horizon. While the still-vivid memory of the Truss/Kwarteng era fiscal plans is likely enough on its own to inhibit attempts at serious unfunded expenditure, spending will likely be further constrained by the party’s commitment not to raise income tax, national insurance, corporation tax, or VAT. This leaves few other options to raise taxes to finance increased spending.

Labour plan to enact several reforms to increase productivity growth, which has been a source of much of the United Kingdom’s economic malaise, albeit one shared by many developed markets. For a start, they plan to build 1.5 million new homes over the next five years, more than 60% above the average completions rate of the last decade. Labour are also aiming to streamline public infrastructure planning, as well as commercial and industrial projects within growth industries. They believe there is also scope to materially increase private sector investment in both capital projects and broader capital markets. A period of economic stability would be a tailwind to boosting such investment, while Labour have also suggested they may look toward consolidation of smaller pension funds as a potential further source of capital investment. Finally, after being partially relitigated at the 2019 election, Brexit was notable by its absence as a central Labour campaign topic during this election. Indeed, Labour have ruled out rejoining the single market or entering a customs union. However, they will likely attempt to eventually deepen ties with Europe via measures such as removing non-tariff trade barriers and fostering alignment on standards.

Structural reforms are by their nature slow and challenging to implement. Even if their execution is successful, it will be at least a couple of years before there is a discernible growth impact. With Labour’s hands largely tied from a fiscal perspective, if partly by their own choice, this election’s short-to-medium impact on economic growth is therefore likely to be modest. Similarly, we expect the market impact to be muted in the near term given both this growth backdrop and how long a large Labour victory has looked assured. Still, UK equities trade at a significant discount to their peers (our preferred valuation metric shows UK equities trading on a multiple of 7.4x versus 17.0x for broad developed markets) and a shift in sentiment could catalyse some catch-up performance. However, we await more concrete signs that the fundamental backdrop is improving and continue to recommend holding UK equities in-line with policy weights.

Thomas O’Mahony, Senior Investment Director, Capital Markets Research

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. Based on daily total net return data as of August 23, 2024.
6. Two seats had not been declared at the time of writing.

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We believe success in co-investing is driven by access to robust and high-quality deal flow, and the current market climate creates additional incentives for GPs to expand their co-investment offerings. Private fundraising ⁷ activity slowed in 2022 and 2023, with respective declines of ~21% and ~35% from its peak in 2021. Though 2024 fundraising data show early signs of recovery, private markets have also underperformed public markets in the short term. The continuing distribution drought has led to skepticism among some LPs about the benefits of private investments, which in our experience has created a dynamic whereby GPs have to work very hard to secure fund commitments.

Co-investments play an increasingly important role in today’s fragile environment for two reasons. First, providing co-investment opportunities allows GPs to build goodwill and showcase their expertise to current and prospective LPs. Second, GPs can use co-investments to make their current fund capital go further. Due to the added incentives for GPs, LPs should benefit from improved access to high-quality opportunities, resulting in a more robust funnel. However, the co-investment evaluation process is critical; LPs must remain wary of adverse selection.

Co-investments offer LPs an important tool to control pacing and express market views. While this is true in any investment environment, it is particularly valuable when private market activity slows. In 2023, global private equity capital deployment was down ~46% from its peak in 2021, and in 2024 it is tracking to a ~43% decline from the historic high. ⁸ Despite this slowdown, GPs are increasingly incentivized to offer co-investments as discussed above. LPs can leverage this co-investment deal flow sourced across GP relationships to manage investment pacing. Further, compared to blind-pool funds, co-investments allow LPs to control specific exposures—and associated risks—in a portfolio. This enables LPs to focus on opportunities that are attractive in the current environment, which can help be identified through the due diligence process. Acknowledging that market volatility has led to allocation constraints for some investors, co-investing can still be a useful tool. Those with direct co-investment programs can adjust annual budgets to respond to market swings, while LPs using co-investment funds can continue to benefit from them by scaling back other commitments.

Co-investments are underwritten based on the current market environment, and today’s landscape should foster more conservative assumptions. Private equity firms synthesize macro and microeconomic data from public and private markets to inform their assumptions that drive financial forecasts and return projections. Typically, GPs provide detailed information about their underwriting to co-investors that can then validate these assumptions as part of their own due diligence process. These factors include, but are not limited to, company valuations, market growth rates, industry dynamics, and the availability and cost of debt. Recently, valuations have fallen from 2021 highs, growth forecasts are more conservative, and higher debt costs have focused sponsors on appropriate capital structures. The confluence of these factors should provide LPs with confidence that the current opportunity set is based on prudent underwriting assumptions. We believe deals struck in this vintage could produce attractive returns in the long run.

While co-investments offer high potential to add value, they are complex to source and execute. Co-investors should have a sound strategy and understanding of where they can be most competitive in finding the greatest value. We believe success is driven by a robust pipeline of opportunities and by having the appropriate resources to be able to transact quickly and efficiently. Today’s market has shifted the incentives of GPs to provide quality co-investment opportunities to LPs, for whom the ability to control capital deployment is increasingly valuable. In response to higher interest rates and a challenging fundraising market, underwriting standards have risen. Co-investors can evaluate these underwriting assumptions and build conviction in today’s opportunity set. Co-investing is a critical component of the private investment ecosystem and one that is particularly attractive today for those that are well positioned and prepared.

Rob Long, Senior Investment Director, Private Equity

Footnotes

1. A unified government occurs when one party wins the White House and both houses of Congress.
2. Please see Jan Hatzius et al., “The Effect of Tariffs on Government Revenue, Growth, and Inflation: Lessons From the Last Trade War,” Goldman Sachs Economic Research, April 6, 2024.
3. See, for instance, the Penn Wharton Budget Model which estimates that Trump’s tax and spending proposals would increase the primary deficit by $1,548 billion between 2025 and 2028, in comparison to the estimated $711 billion increase that would result from Harris’ proposals.
4. John Bistline et al., “Emissions and Energy Impacts of the Inflation Reduction Act,” Science, Vol 380, Issue 6652 (30 June 2023): 1324–1327.
5. Based on daily total net return data as of August 23, 2024.
6. Two seats had not been declared at the time of writing.
7. Private fundraising refers to buyout and growth equity funds.
8. The 2024 fundraising activity is annualized based on data as of March 31, 2024.

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