Running offers a unique opportunity to reflect, allowing thoughts to drift and settle in ways that daily life often doesn't permit. During a recent run, I found my mind wandering to how to think about investing for the long-term by shutting out the chatter, noise and recency bias of market strategists and how to avoid falling into a trap of certainty in a system that is inherently uncertain.
In his memoir “What I talk about when I talk about running”, the author Haruki Murakami parallels between running and writing, noting how both require persistence, routine, and a strong inner resolve. The same can be said about investing, particularly when you are investing for the long-term.
What follows is a collection of my views on some of the investment topics and themes that I have been reflecting on. These are my personal views, and not investment advice, or a recommendation of any particular strategy or product. Rather, they reflect how I would position my own portfolio, and that of my clients in order to maximize the probability of long-term success.
The Economy : Believe in prosperity
A slowing of the economy and rationalization of asset prices is not extraordinary and should be expected. However, betting against prosperity and human ingenuity has historically been a negative sharpe ratio ratio trade, and I don’t believe a long-term investor should abandon risk-taking in the face of a slowdown.
The global economy in general and the US economy in particular seem to be in decent shape. With positive real rates, there is enough room for central banks and policy makers to maneuver in the event of any systemic shocks.
America seems to have got inflation in control, and the Fed has 500 bps of rates to play with should any stress in the system arise. China seems to be coming out of their regulation-induced slowdown, and India continues to grow. The Middle East sovereign funds and governments have demonstrated exceptional long-term thinking and technocratic principles that ought to bear long-term fruit.
While systemic shocks by definition are unpredictable, should one happen, traditional ‘macroprudential’ tools and policies may indeed be able to help manage the fallout. Geopolitics are a wild card, but in the absence of information to the contrary, staying the course and believing in long-term prosperity may be the trade with the higher odds.
Public Equities & BigTech : Stay Invested, but close to your long-term target
Equities in general, and Big Tech in particular have had a wonderful run, and there are rational reasons to worry about valuations and concentration.
As a long-term investor I am hesitant to completely get rid of exposure to Big Tech. These are well run companies, generating some of the healthiest profit margins in history. Their management has the mindset and the capacity to allocate capital and talent toward the next big thing at a speed and scale that very few others can do. The steps that these firms have taken in the past year in AI are an example of that. The strategy and research teams at these firms probably have a stronger pulse on innovation than what we as investors can expect to have. So even if there is a risk of over-valuation, it's a risk I am willing to bear.
Having said that, after the extra-ordinary run up in asset prices over the past few years, a 20-30% decline in stock prices should be expected in the normal course of business, and not something to panic about.
However, applying a behavioral utility and risk management lens, it may not be a bad idea to buy some downside protection and also take some gains by diversifying into less correlated risks.
Where to Diversify : Factors, Risk Premia, Credit & Being Smarter in Private Markets
Factors & Premiums:
Reducing concentration to Big Tech can become attractive by rotating capital into Factors, Sectors and Geographies with positive expected returns. I prefer adding some size, quality, and value exposure to diversify the large cap, tech, and momentum bias embedded in Big Tech and indices such as the S&P 500.
Instead of using my risk and fee budget on benchmark-hugging long-only active managers, I prefer to diversify into alternative risk premiums, and specific private market strategies, where you can earn a higher premium for the risks that you take.
Smarter Private Markets - Changing how you allocate to private assets:
With private market allocations approaching a quarter to a third of most institutional portfolios, private market portfolio construction is undergoing a necessary and exciting change.
Instead of ‘all private returns are alpha’, allocators are moving toward understanding the excess returns that individual managers deliver over and above factor exposures that an allocator can access through other sources.
Allocators are beginning to recognize that metrics like IRR may not reflect the total returns or wealth creation that are built into the expected return assumptions that have driven their allocation to private markets in the first place. Allocators are also beginning to look at their portfolio liquidity and cash flows holistically. I have written more about this in my Quantitative Revolution essay.
Private market allocation and alpha generation becomes even more interesting when you look at factor and risk premia across both equity and credit and view public and private investments through a common lens.
At a conceptual level, public and private investments are claims on future cash flows of an entity, either in the form of contractual (e.g., debt) or residual (e.g., equity). Therefore they share common characteristics, and at the same time have several important differences. Identifying the common factors, and identifying the areas where they differ can lead to superior portfolio construction - both in terms of solving key challenges that private market investors face, and in improving the ability to generate superior long-term returns.
Combining public and private, equity and credit also opens up a new dimension in portfolio construction. Such a combined approach can solve deployment and cash flow issues that private allocators face - public investments help fully deploy capital, maintaining the compounding engine and helping an LP meet their expected return assumptions (vs. earning only about half their assumptions in a typical private j-curve). Combining public and private can also improve cash flow predictability.
The Portfolio Alpha Opportunity from Converging Equity and Credit Risk Premiums:
Across both public and private markets, equity and credit risk premiums have converged.
For similar macro risks, one is now getting paid a similar amount whether they are invested in equity or credit.
This leads to an interesting portfolio construction opportunity. Not only does that open up credit as a diversifier without significant reduction in expected returns, but it also changes the nature of how you generate alpha. For example, you might want to diversify your credit (lowering left tail risk) while concentrating your equity (exposing yourself to right tail risk). In a subsequent article I plan to expand upon this concept.
Putting all of this together:
Total portfolio allocation in this environment calls for a balanced approach:
Equity and Credit Premiums: Maintain a balanced exposure to equity and credit risk, focusing on diversifying credit and concentrating equity alpha
Big Tech: Expect 20-30% drawdowns but maintain exposure to Big Tech due to their potential for innovation and non-linear upside, while considering duration/tactical hedges to manage overvaluation risks
Factor & Alternative Premiums: Use to allocate away from Big Tech and deploy excess capital. In equities, favor exposure to size and quality factors, which can provide a robust risk-return profile without relying on benchmark-hugging active managers
Private Markets: Use diversified private credit for steady returns, be highly selective private equity for upside, and solve for liquidity/distribution concerns by pairing uncertain cash flows with liquid instruments that offer similar factor exposures
Investing, much like running, is about embracing the process and staying flexible - mindful of the path, steady in our pace, and always prepared for the unexpected. A commitment to continual learning and a willingness to adapt are crucial. The goal is not to predict the future with certainty but to remain disciplined and resilient, navigating through uncertainty with a clear focus on long-term objectives.