Investing in Motion: Driving Trends Forward

I believe factor-based quantitative investing has demonstrated a strong ability to be flexible and adaptive. Taking into account many components such as market sentiment, valuation, and growth, among others, has allowed this allocation style to find opportunities across market swings. And while simply owning the index has worked well in the past, as the swings in style revert, the concentration of stocks in indexes—a powerful force, of late—could revert significantly in a new direction. Factor-based quantitative and systematic strategies represent a form of investing that allows people to build portfolios based on specific objectives, underlined by self-determined rules, guidelines, and styles.

A properly structured quantitative strategy, one that has proven its muster via a systematic way of investing through a variety of market environments and opportunity sets, can potentially offer outperformance with lower volatility. These advantages are largely due to the inherent characteristics of a well-designed, thoughtful—and dynamic—method for actively capturing the market trends of today and tomorrow.

And investors may be taking notice.

Prepare for a Fast Getaway

One of the areas getting more attention lately has been liquidity or, better said, the proper analysis of illiquidity discounts. As many investors have shifted portions of their portfolios into private debt and private equity vehicles, this is becoming a larger, more noteworthy discussion (Exhibit 2). Over the past couple of years, the assumptions on cash flows from private investments have broken down with private equity sponsors, in particular, not having the expected portfolio monetization to return capital to investors in a timely fashion. Some investors have therefore been forced to create liquidity in other parts of their portfolios to fund capital calls and other commitments. 

Should this illiquidity discount change the way investors weigh the pros and cons of investing in private markets versus public markets? The answer may be yes.

Historically, private markets were sufficiently different from public markets. Exposure one would get in private markets was generally associated with smaller companies, seed funds, special situations, restructurings, and other such opportunities. These companies were often at an earlier stage of development than larger, more established public companies—and ones with different sets of risks.

Private investments, therefore, created a diversification benefit for investors, or an investment opportunity that paired a liquidity discount with potentially differentiated returns. However, as private markets start to present more like their larger and more developed peers, as is often the case today, portfolio diversification benefits may have become conflated. With this convergence, the fundamental differences between private and public could be slowly eroding, except when it comes to liquidity.

Many portfolios that have leaned too heavily into private markets in the past may find that they are now mired in old liquidity assumptions. For some, tapping into liquidity may be more rigid, complex, and costly than fully anticipated.

In my opinion, it is important to understand the true liquidity exposure that is generated from any investment regardless of whether this is driven in a public or private landscape. As the credit and equity exposures in private investments become more like publics, how we compare and evaluate allocations would need to be informed by other factors such as fees and liquidity to make the appropriate risk-reward decision. 

Where Should Investors Put Their Money?

Over the past years, in my opinion, US dollar strength and the strength of US markets have been nothing less than extraordinary. As investors shift more and more toward US allocations, this has created even further structural momentum to the widening relative valuations we are seeing in markets across the globe (Exhibit 3). Structural and technical shifts can create opportunities if investors are willing to look beyond what is currently in vogue and focus on finding value in areas of market inefficiency. After all, when markets begin to skew, as they currently are, investors should take notice.

While choosing the right allocation mix is relative to individual portfolio needs, I believe that the ability to move allocations dynamically is the future of the system overall. Opportunities can be found at attractive valuations throughout emerging, international, and global markets, and in categories like quality, relative value, and small cap. While it may seem that these opportunities have been out of (relative) favor for some time, for active investors, getting in on the ground floor is what I consider to be the real opportunity set.