Portfolio Adviser took up the opportunity to run some questions by Niall O’Sullivan, chief investment officer, multi-asset strategies, EMEA at Neuberger Berman.
We covered plenty of ground, including his macro outlook, whether markets are pricing the situation correctly, the banking sector and the best opportunities for investors.
Here is what he told us.
How did you find your way into investing as a career, and what were the main steps that brought you into your current role?
Having done mathematics in university, I was keen to find a role in finance. I applied to an investment bank in a department that would have been totally unsuitable.
In one of the random acts of kindness that ultimately enables any career, the person who interviewed me did not throw my CV in the bin. She took the trouble to connect me with a more relevant team, and I went from there.
Over time, I realised that my passions were fired by trying to understand markets and working with teams to construct portfolios that solve client problems.
My role as CIO at Neuberger Berman allows me the opportunity to do that with clients all over world with various portfolio needs, while collaborating with outstanding investment teams.
What is your base case for how the global economy will develop over the coming two to three years in terms of inflation, monetary policy, trade and growth?
We are adapting to a new data driven world for central banking. The comfort blanket of almost 15 years, where central banks were clear on what they were going to do and backed it up by actions is no more. Now, they react to the data as it comes in, making every release a “set piece”.
Markets are pricing in that inflation will return close to normal levels quite quickly – much quicker than when inflation has been this high historically. We believe it will be a disinflationary world and inflation will fall, but the process may take longer than people think.
The dynamics of operating in a multi-polar world are likely to be inflationary also. More importantly, the central banks know this history, and this will mean they will be cautious to ease until they are sure inflation is under control – as we have seen in recent ECB and Fed actions.
Such an environment – allied to the pressures on bank balance sheets – is one that is unlikely to be conducive to strong growth.Therefore, we see a slowdown coming and the potential for recession in multiple countries, with those across Europe as an example.
In what respects is this outlook correctly priced into markets, and where are investors misjudging things?
Where we are most concerned is in developed market equities.Valuations are high, equity risk premia are low and earnings do not truly reflect the slowdowns mentioned above.
There are pathways to how these levels make sense, but they revolve around either a very specific type of recession that is severe enough to cause the central banks to cut rates and keep them low, but benign enough that it does not produce significant earnings pressure – or, it requires new disruptive growth enabled by transformative technology such as AI.
While we recognise the power of the new developments and their ability to change the markets, we think this is more of an alpha play and a lens to identify winners and losers than it is something that can support the market as a whole.
On the other hand, the inverted yield curve and the work done by corporate treasurers to prepare balance sheets make various forms of short-dated fixed income attractive and we think you can be paid to be patient while we wait to see what unfolds on the equity side.
How is the turmoil in the banking sector in particular impacting markets in your view?
The banking sector turmoil will tighten financial conditions and ultimately do some of the job of the central banks for them, meaning the required hikes by central banks will be less.
We are a little wary of some of the more extreme narratives that have built up that the availability of credit will evaporate. If Bank A is taken over by Bank B, then as long as the combined entity does the lending that each bank did, the credit availability is the same.
Ultimately, banks need to lend to be profitable and so they will at some stage lend again. However, in the short-to-medium term a combination of increased regulatory scrutiny and a distraction due to wider volatility will put pressure on bank lending.
We are seeing this both in the loan officer surveys in Europe and the US and anecdotally from our clients and general partners. This is presenting very interesting opportunities in private credit.
We are seeing that in our senior lending business deals, there has been lower leverage being done at higher spread and bigger discounts, even when you are saying no to most of the deals you are offered.
In more opportunistic credit solutions the lending slowdown, allied to a corporate desire to avoid being forced to raise equity, is leading to compelling transactions also.
What are your highest conviction calls at the moment in terms of parts of the markets investors should target?
In addition to what we have covered already, I would focus on two meta themes. First, this is a world where there has and will be incidents. 2022 saw the UK gilts crisis, concerns on euro periphery debt (“solved” by the transmission protection instrument) and the >$1trn of capital destruction in cryptocurrencies.
So far in 2023, we have seen two of the largest bank failures in US history. Overarching this is the ongoing denominator effect where many large asset owners must allocate less to private markets or, in extreme situations, sell off existing holdings in secondary markets.
In a world like this, there are rewards for being a capital provider to areas in which capital is scarce and investing where you are solving a problem for market participants.
Clearly, the foundation of a strong private market programme is vintage diversification and consistent allocation over time.
However, at the margin, we are favouring allocations to areas such as private equity secondaries in current vintages. Second, the hunt for uncorrelated strategies remains as important as ever.
Tactical macro managers that can genuinely go anywhere, should have the ability to generate value once they can manage risk.
Combining both these themes, assets such as insurance linked securities, that combine the reward for a scarcity in capital formation with uncorrelated outcomes, are playing an increasing role in our clients’ portfolios.
