The first four months of 2022 have been characterized by a series of unpredictable events – including a jarring face slap at the Oscars, a swift and cinematic (pending) takeover of Twitter, and unseasonably elevated market volatility. While markets will inherently exhibit some level of volatility, a combination of unique economic factors has resulted in a rather potent cocktail that many investors have yet to digest.
Given the rapid onset and historically disruptive impacts of the pandemic, the Federal Reserve had no choice but to slash interest rates and flood the market with liquidity – otherwise known as quantitative easing. This of course resulted in a historically low interest rate environment which in turn made capital very easy to come by – resulting in a state of market euphoria that welcomed investors both large and small. That is, until the pandemic (and now a Ukrainian war) ushered in a wave of supply chain constraints that produced a level of inflation not seen since the early 1980s – giving central banks no choice but to turn off the faucet.
This is the reality that we find ourselves in today; interest rates are rising, equity multiples are compressing, and to quote country music artist Ronnie Dunn (i.e., Brooks & Dunn) – the cost of livin’s high and goin’ up. This results in a very tricky dichotomy for investors, particularly because equities and fixed income (the value of which has an inverse relationship to interest rates) are both correcting in lock-step – two asset classes that have historically demonstrated a negative relationship with one another. In fact, the U.S. Aggregate Bond Index is down over 10% year-to-date while the S&P 500 sits 14% off its previous record high – a strange and rather discouraging reality for the typical investor.
At Silicon Hills, we’ve been monitoring this economic transition and realized several months ago that frothy equity multiples and historically low interest rates (which were bound to rise at some point) would soon erode traditional public market portfolios. In fact, we provided the following remarks in our 2021 year-end commentary:
With interest rates sitting near all-time-lows, inflationary pressures and subsequent monetary policy tightening are likely to force rates even higher – the result of which could be detrimental to investors relying on some combination of cash and fixed income for capital preservation. Not only would equities encounter headwinds along the way, but inflation would result in a negative yield for cash and rising interest rates would produce a negative return for most fixed income – the combination of which could be devastating.
We also discussed a periodic repositioning of our investment program based on the following tenets:
- Equities may seem overvalued, but there is still plenty of opportunity in the market.
- Despite the risks and recent market volatility, the opportunity cost of not participating in equity markets is substantial.
- Diversification within asset classes can be obtained just as effectively as diversification across asset classes.
- Alternative investment strategies are becoming increasingly vital to portfolio construction – especially when compared to traditional fixed income.
Considering the S&P 500 peaked just seven trading days after this article was published on December 22nd, we remain strongly convicted in our findings. Attempting to time entry or exit into the market is a failing strategy with significant opportunity cost, but emphasizing quality within equities and leveraging alternative risk-managing vehicles (in lieu of traditional fixed income) has provided much-needed stability for our clients. In fact, many of our clients have likely noticed a series of trades in recent months introducing a value-tilt within equities, as well as one or more of the following alternative strategies:
A systematic, quant-based strategy that can take long and short positions in various futures markets – including commodities, currencies, and other derivative instruments.
Another systematic, quant-based strategy that buys and sells volatility contracts on the S&P 500 – offering a means of crisis alpha in severe tail-risk events such as the pandemic-induced selloff in early 2020.
Target Risk & Style Premia Funds
Leverages systematic, risk-budgeting approaches to remove market risk and capture the returns of various risk premiums – including equity risk, interest rate risk, credit risk, and inflation risk.
Provides equity exposure to privately-owned companies – typically sub-categorized as venture capital, growth equity, or buyouts depending on the maturity of the underlying companies.
Refers to debt investments not financed by banks or traded on an open market – characterized by the quality and structure of the underlying debt.
Represents the largest alternative asset class with investments falling into one of three categories – real estate, infrastructure, or land and natural resources (i.e., commodities).
Rising interest rates and compressing equity multiples have resulted in a dual headwind for most traditional public market portfolios, and though the future can’t be predicted with any degree of certainty, we believe that portfolios should be prepared for a significant and persistent regime shift. At Silicon Hills, we’re focusing on high-quality equities and a series of alternative investments to do exactly that – and we don’t foresee that changing anytime soon. Publicly-traded equities and fixed income have faced an uphill battle thus far in 2022, but by tapping into uncorrelated, non-traditional asset classes – our clients can remain confidently invested across all market cycles despite the unpredictable events that may lie ahead.
Disclaimer: This document may contain forward-looking statements and projections that are based on our current beliefs and assumptions and on information currently available that we believe to be reasonable. All statements that are not historical facts are forward-looking statements, including any statements that relate to future market conditions, results, operations, strategies or other future conditions or developments and any statements regarding objectives, opportunities, positioning or prospects. Forward-looking statements are necessarily based upon speculation, expectations, estimates and assumptions that are inherently unreliable and subject to significant business, economic and competitive uncertainties and contingencies, and prospective investors may not put undue reliance on any of these statements. Forward-looking statements are not a promise or guaranty about future events.
It should not be assumed that recommendations made in the future will be profitable or will equal the performance stated herein. The information provided does not constitute investment advice and is not an offering of or a solicitation to buy or sell any security, product, service or fund, including the fund being advertised.
The statements herein are not intended to be complete or final and are qualified in their entirety by reference to the Investment Management Agreement. In the event that the descriptions or terms described herein are inconsistent with or contrary to the descriptions in or terms of the Investment Management Agreement, the Investment Management Agreement shall control. In making an investment decision, you must rely on your own examination of the Investment Management Agreement.