Andy Hart Discusses Climate Change's Impact on Investment Strategies with MarketCurrents

As climate change impacts the planet through hurricanes, rising water levels, floods and more, it is also impacting the way investors manage and mitigate risk in real estate investments. For specific insights on how climate change is impacting real estate investments, MarketCurrents recently spoke with Delegate Advisors Managing Partner Andy Hart.

“Climate change is now an active part of our discussions with clients,” explains Hart. “I think there is interest in divestments from certain properties before there is a tangible shift in attitudes on climate change.”

This is especially true throughout many areas of the U.S. where the future impact of climate change is already affecting property values. For example, the First Street Foundation, a New York-based nonprofit that looks at the impact of rising water levels and flooding, recently reported that nearly 20 coastal cities across the country have already seen property value eroded due to the impact of climate change.

Furthermore, a report from the Urban Land Institute stated that institutional investors and wealthy property owners must take risks from climate change into account or risk a decline in the value of their assets as the market reallocates capital to locations less prone to the impacts of climate change over the long term.

Click here to read the entire MarketCurrents article.

Things You Should Know: The U.S. Moves Closer to a Trade War with China

Throughout the month of May, tensions escalated between China and the United States regarding trade between the two global economic superpowers. After negotiations broke down early in the month, President Trump announced that the U.S. would be raising tariffs from 10% to 25% on $200 billion worth of Chinese imports. Trump added that U.S.-applied tariffs on Chinese goods entering the country could “go up very, very substantially, very easily,” as his administration is currently considering applying a 25% tariff to the remaining $300 billion of Chinese imports that is currently tariff-free. In retaliation, China announced an increase of tariffs on $60 billion of U.S. goods that too effect on June 1.

Markets remain hopeful that the two nations will come to a comprehensive trade agreement that will eliminate these tariffs and allow products to move freely across borders, but the risk remains that the situation continues to escalate into a full-blown trade war. While economists’ opinions differ on the magnitude of the effects of such an outcome, virtually all agree that the effects will be negative. The Organization for Economic Cooperation and Development estimates that further escalation would decrease global growth by 0.7% by 2021, and Morgan Stanley analysts opine that if the U.S. imposes tariffs on the remaining $300 billion of Chinese goods, the domestic economy would be heading towards recession.

We believe that the risk of further escalation between the U.S. and China is the single biggest risk in the financial markets right now, as both sides continue to “dig in their heels.” In response to this risk, we are advising our clients to shift to a more conservative posture, generally reducing portfolio allocations to global equities and higher-risk fixed income while building positions in short-term, investment-grade fixed income and cash.

Download this article here.

Disclaimer: This material is for information purposes only and for the use of the recipient. Under no circumstances is it to be considered an offer to sell, or a solicitation to buy any investment referred to in this document. Although we believe our sources to be reliable and accurate, we assume no responsibility for the accuracy of such third‐party data and the impact, financial or otherwise, it may have upon any client’s conclusions. Delegate Advisors, LLC, has not audited or otherwise verified this information and accepts no liability for loss arising from the use of this material. The information contained in this document is current as of the date indicated. Delegate Advisors, LLC, undertakes no obligation to update such information as of a more recent date. Any opinions expressed are our current opinions only. Nothing herein should be construed as investment, legal, tax or ERISA advice. You should consult with your independent lawyer, accountant or other advisors as to investment, legal, tax, ERISA and related matters to which it may be subject under the laws of the country of residence or domicile concerning the acquisition, holding or disposition of any investment in the account. Past performance is not indicative of future results. All investments involve risk including the loss of principal. Any investments discussed within this material may be subject to various fees and expenses, which will have a negative impact on performance.

Dunkin Allison Discusses Municipal Bond Funds with U.S. News & World Report

High-tax bracket investors are becoming increasingly interested in enhancing their portfolio’s income through municipal bond funds. Why are municipal bond funds suddenly so appealing? U.S. News & World Report recently spoke with Delegate Advisors Co-Chief Investment Officer Dunkin Allison to answer this question.

According to Allison, municipal bond funds have recently experienced relatively strong returns due to a combination of two important factors: a solid U.S. economy with low unemployment, and a low supply combined with a strong demand because of a historically low-interest rate environment.

However, not all municipal bond funds have the potential to add value to an investor’s portfolio. As a result, Allison examines each bond closely by looking at credit quality versus its risk, duration and cost before investing in a municipal bond fund.

With these aspects in consideration, Allison currently favors short-duration bond funds with five years or less to maturity, given today’s interest rate environment. Specifically, Allison tells U.S. News & World Report that he sees the most potential in actively managed bond ETFs where opportunities exist for portfolio managers to perform better than their benchmark. Allison explains that in a low-return environment, costs are important when looking at actively managed funds, which usually have higher fees than passive ETFs.

“If you’re paying that’s 1% or more, you’re eating into a tremendous amount of return,” explains Allison.

Read the entire U.S. News & World Report article here.

Jim Powers Discusses First-Quarter Earnings with

Investors were skittish the day before first-quarter earnings reports from major Wall Street banks were due to be released, as declining earnings expectations caused uncertainty across financial markets.

Currently, first-quarter earnings are expected to decline 4.2 percent year over year for S&P 500 companies, according to FactSet, which is slightly lower than the 3.9 percent decline predicted just one week before. If this prediction rings true, it would be the largest year-over-year decline in earnings since the first quarter of 2016.

How should investors react to this expected decline? spoke with Delegate Advisors Co-Chief Investment Officer and Chief Compliance Officer Jim Powers to answer this question.

According to Powers, the primary focus for investors will be on companies’ guidance as it “will let us know what to expect, whether (potentially negative earnings) is a one-quarter blip or if we’re moving into an earnings recession.”

To read the entire article, click here.

Andy Hart Discusses IPO Impact on Bay Area Real Estate Market with San Francisco Chronicle

This February, the volume of Bay Area home and condo sales increased by 12.9 percent from January. Despite this surge, year-over-year sales volume remains down by 12.8 percent from this time last year as both buyers and sellers are waiting to see how an onslaught of initial public offerings (IPOs) will impact the real estate market.

It is estimated that 180 companies will go public on U.S. exchanges in 2019 with a total of $60 billion raised. This not only includes the newly public Levi Strauss and Lyft, but also likely IPO candidates Uber, Pinterest, Slack and Postmates, all based in San Francisco, and Zoom, which is based in nearby San Jose.

So, how will this surge of new IPOs effect Bay Area real estate? And, more importantly, how should potential buyers and sellers react to these changes? The San Francisco Chronicle recently spoke with Delegate Advisors Managing Partner Andy Hart to answer these crucial questions.

In the article, Hart says that he believes there will be “a scramble for homes” in San Francisco and surrounding counties for properties ranging from $1 million to $4 million. Despite this surge, he cautions clients not to buy homes based on how much they think their new stock is worth before the end of the lockup period, which typically lasts six months and prohibits people who invested in the company before it went public from selling shares.

“I’ve seen that rodeo before, when people thought they had a certain amount of money and then they didn’t,” explains Hart. As a result, he advises them “to be patient.”

Read the entire San Francisco Chronicle article here.

Andy Hart Discusses How to Invest with a Weakening Dollar with U.S. News & World Report

Through the end of March, the U.S. dollar’s year-to-date return was marginally weaker against a basket of other currencies, and this softness may continue throughout the year. In order to better understand how investors can take advantage of a weakening dollar, U.S. News & World Report recently spoke with Delegate Advisors Managing Partner Andy Hart. In the article, Hart discusses three ways to invest when the dollar is falling: sovereign debt, international company debt, and emerging market equities.

According to Hart, sovereign-debt investments possess the potential to perform well when the dollar softens. When researching these foreign fixed-income investments, he recommends that investors search for countries that are rated by credit agencies as investment grade. A weakening dollar is then able to benefit these investments in two ways: currency appreciation and the discrepancies in interest rates between the U.S. and the other country.

Another debt-focused investment to consider when protecting against a weakening dollar is international company debt. As with sovereign-debt investors, fixed-income investors in international corporate debt can also earn a profit as long as they look for companies with investment-grade debt.

Lastly, Hart says investors diversifying their portfolios with emerging market equities can benefit from a falling dollar in a multitude of ways. Emerging market equities are typically focused on commodities. As a result, “they get a bump in activity when commodities’ prices rise, but more importantly, most of their debt is dollar denominated,” says Hart.

Due to this connection, when the dollar falls relative to the currency where they generate revenue, the cost of paying their debt also falls. Companies with large international sales benefit since they are paid in a higher priced currency. However, in order to avoid having too much exposure to one country, Hart recommends using a diversified cap-weighted index fund.

To read the entire U.S. News & World Report article, click here.

Things You Should Know: The Yield Curve Inverts

On Friday, March 22, 2019, the yield curve inverted when the yield on 3-month U.S. T-bills exceeded the yield on 10-year U.S. Treasury notes by 2.2 bps at the end of the trading day. As we noted in two of our 2018 quarterly letters, we have been monitoring the curve closely. Typically, long-term rates are greater than short-term rates, and the yield curve is “upward sloping.” In a very general sense, when the yield curve inverts, short-term rates rise above long-term rates, and the yield curve becomes “downward sloping.” Two potential reasons for a yield curve inversion could be that investors are fleeing to safety and buying up safe, long-term assets, driving up the price of these assets and pushing the “long end” of the yield curve downward (bond prices and yields move in opposite directions). Alternatively, overly aggressive central bank tightening could cause a spike in short-term rates, driving the “short end” upward.  

Inversions of the yield curve are a major phenomenon to watch because they have preceded the last seven post-war recessions, with only two “false positives” (i.e., the yield curve inverted and a recession did not occur until after the next inversion). While an inverted yield curve often portends recession, the actual inversion is not, however, generally a signal to sell risk assets immediately. According to Bianco Research, the beginning of a recession (i.e., two consecutive quarters of negative GDP growth) follows the inversion of the yield curve by 311 days on average. Thus, we treat the fact that the yield curve inverted as one of many recent signals that have caused and continue to cause Delegate to recommend an increasingly conservative posture towards risk assets. Other troubling signals include the record high U.S. budget deficit and reductions in global GDP projections.

Because of these concerning signals, we continue to advise our clients to trim public equity and higher-risk fixed income exposures when appropriate, potentially to below policy targets, and to build cash balances to take advantage of market downturns.

Andy Hart Develops an Opportunity Zone Checklist with ThinkAdvisor

The idea of opportunity zone investing is rapidly increasing in popularity. In fact, according to the National Council of State Housing Agencies, more than $18 million worth of investment plans in these zones has already been announced before IRS regulations have even been finalized.

Are opportunity zones actually a good investment? ThinkAdvisor recently spoke with Delegate Advisors Managing Partner Andy Hart to develop a checklist that can help investors answer this crucial question.

The first aspect to consider when analyzing an opportunity zone investment through a fund structure is the quality of the fund manager. Alignment of interest between the fund manager and its investors is highly important. According to Hart, this alignment is much more likely if the fund manager is also an investor in the fund and “has skin in the game.”

Next, it is important for potential opportunity zone investors to examine the individual deal(s). “First and foremost read through the documents,” explains Hart. “You need to be sure they comply with the regulations, not that the fund ‘will comply’ with the [regulations] when they’re finalized.”

When examining the deal(s), it is also important to determine if the fund plans to invest in real estate markets that have already experienced price inflation due to the growing excitement around opportunity zones, such as parts of New York City. For example, Hart reports that the seller of a piece of real estate located in an opportunity zone recently hiked the price by 20% simply because it was located in an opportunity zone.

Another question to ponder: does the fund/investment manager have processes and procedures in place for independent verification of compliance regulations?

When referring to the legislation that grants opportunity zone funds the ability to certify themselves by filing a form with their federal tax return, Hart warns, “Trust but verify… You don’t want to rely on the manager for self-certification.”

Lastly, Hart believes investors should be wary of excessive fees, which can be common among real estate fund managers.

Read the entire ThinkAdvisor article here.

Things You Should Know: Emerging Market Equities

In our Delegate Advisors Asset Class Indicators for the first quarter of 2019, we raised our outlook for emerging market equities from underweight to neutral-to-overweight, reflecting what we believe to be an attractive long-term opportunity. The shift in outlook is based primarily on the current valuation of the asset class. As shown in the below chart, the cyclically-adjusted price-to-earnings ratio (“CAPE”) for emerging market equities was 12.1 as of 12/31/2018, well below its 10-year average of 14.7.

Screen Shot 2019-03-06 at 3.23.36 PM.png

Additionally, while emerging market equities naturally have lower valuations relative to developed markets due primarily to the inherent risks of the asset class, the spread between the valuation of emerging markets and developed markets is currently wider than average, implying that, relative to global developed markets, emerging markets represent a better value.

Given this backdrop, we expect emerging market equities to outperform developed markets over the long term as their valuation converges to the long-term average and as the spread between valuations for developed and emerging markets tightens.

One caveat, however. While emerging market equities may currently appear undervalued, the asset class is historically very volatile, meaning that large, sudden moves (both positive and negative) are common and expected. Thus, investors who are unwilling to “ride out” this volatility should consider an alternative.

Download this article here.

Disclaimer: This material is for information purposes only and for the use of the recipient. Under no circumstances is it to be considered an offer to sell, or a solicitation to buy any investment referred to in this document. Although we believe our sources to be reliable and accurate, we assume no responsibility for the accuracy of such third‐party data and the impact, financial or otherwise, it may have upon any client’s conclusions. Delegate Advisors, LLC, has not audited or otherwise verified this information and accepts no liability for loss arising from the use of this material. The information contained in this document is current as of the date indicated. Delegate Advisors, LLC, undertakes no obligation to update such information as of a more recent date. Any opinions expressed are our current opinions only. Nothing herein should be construed as investment, legal, tax or ERISA advice. You should consult with your independent lawyer, accountant or other advisors as to investment, legal, tax, ERISA and related matters to which it may be subject under the laws of the country of residence or domicile concerning the acquisition, holding or disposition of any investment in the account. Past performance is not indicative of future results. All investments involve risk including the loss of principal. Any investments discussed within this material may be subject to various fees and expenses, which will have a negative impact on performance.

Delegate Advisors Shortlisted for the 2019 PAM Awards in Two Categories

We are pleased to announce that Delegate Advisors has been shortlisted for the 2019 Private Asset Management (PAM) Awards in two categories: Best Multi-Family Office - Client Service - Under $2 Billion and Best Registered Investment Advisor (RIA) for High-Net-Worth Clients.

The PAM Awards recognize the best investment professionals, wealth advisors, legal firms, consultants, and other key service providers in the private wealth management industry that have achieved notable accomplishments throughout the past year. An independent judging panel made up of industry experts determines the winners of these awards by examining both qualitative and quantitative performance indicators.

Commenting on the firm’s shortlisting, Delegate Advisors President and Chief Advisor Andy Hart says, “Each of our clients is unique with different needs and challenges, so we make it our top priority to provide customized, creative, solutions for them to meet all of their financial goals. It is very rewarding to have these efforts noticed by PAM.”

The winners for this year’s PAM Awards will be announced during an evening awards ceremony on Thursday, February 7, 2019 in New York. More information regarding the awards is available here.

About the Private Asset Management Awards:

The annual Private Asset Management Awards - presented by Private Asset Management (PAM) Magazine - is an evening of recognition and reward for top investment professionals, wealth advisors, legal firms, consultants, and other key service providers operating within the private asset management industry. Judges will take part in a judging conference call, where the winners will be decided. Our expert judge per category will be asked to summarize the judges’ comments. Judges have discretionary power to move submissions into alternative categories that they think may be more suitable. All judges are required to sign a disclaimer form to keep information about entries and the final winners confidential. The judges are carefully selected for their wealth of experience and expertise, as well as their absence of conflicts of interest. Judges cannot judge any categories that their company has submitted for and are obliged to declare that they have no conflicts of interest prior to judging.

Delegate Advisors Shortlisted for the 2019 Family Wealth Report Awards

We are pleased to announce that Delegate Advisors President and Chief Advisor Andy Hart is a finalist for the Family Wealth Report Awards in the Outstanding Contribution to Wealth Management Thought Leadership (MFO/Wealth Advisor/Manager) category.

The winners of the 2019 Family Wealth Report Awards will be determined based on the finalists’ independence, integrity, and genuine insight. In order to ensure that commercially sensitive information is kept confidential and to avoid conflicts of interest, there will be two judging panels for the awards. One panel will be responsible for judging the private banking categories, and the other will judge the trusted advisor categories.

“Being shortlisted for the Family Wealth Report Awards is a great honor,” comments Hart. “Delegate Advisors is a special team that constantly puts the needs of our clients first. We focus on delivering quality independent wealth advice, and it is a great feeling to have our efforts recognized.”

The winners of the Family Wealth Report Awards will be announced during an awards dinner at the Mandarin Oriental in New York City on March 20, 2019.

About ClearView Financial Media LTD (“ClearView”)

ClearView Financial Media was founded by Chief Executive, Stephen Harris, in 2004 to provide high quality ‘need to know’ information for the discerning private client community. London-based, but with a truly global focus, ClearView publishes the Family Wealth Report group of newswires, along with research reports and newsletters, while also running a pan-global thought-leadership events programme. With teams based in New York, London, Singapore, Switzerland, South Africa, and Malaysia, the company is one of the fastest-growing media groups serving the financial sector.

Andy Hart Discusses Amazon's New Opportunity Zone Location with ThinkAdvisor

After months of speculation, Amazon finally announced the locations of its two new headquarters: Long Island City, New York and Arlington, Virginia. This announcement has sparked interest among certain investors, particularly because the Long Island City offices will be located in an area that is part of one of New York’s Opportunity Zones. According to the Tax Cuts and Jobs Act of 2017 and subsequent preliminary IRS and U.S. Treasury guidelines, investors in Opportunity Zones, such as Amazon, may be eligible for certain tax benefits if the Opportunity Zone investment meets certain guidelines.

Amazon’s new Opportunity Zone location has generated substantial feedback and many questions, with many wondering if the Long Island City headquarters will fulfill a major purpose of Opportunity Zones: economic benefits for people living and working in the area.

To help understand the potential impact of Amazon’s Opportunity Zone story, ThinkAdvisor recently spoke with Delegate Advisors President and Chief Advisor, Andy Hart. In the article, Hart states that the Amazon development could benefit local residents as long as the city established certain policies for Amazon to follow. For example, a ban on in-house cafeterias on the new Amazon campus could encourage the development of local restaurants and, as a result, more jobs for local residents.

Hart also describes how, depending on investor preferences, the most attractive Opportunity Zone investments may be located in the upper right-hand corner of a chart where the y-axis measures the financial health of the investment and the x-axis measures its social impact. “We’re trying to have both,” explains Hart, who notes that Opportunity Zones should be a “real boon to the real estate industry” while potentially sparking economic development.

Read the entire ThinkAdvisor article here.

Andy Hart Discusses Opportunity Zone Investments with American Banker

On October 19, 2018, the Internal Revenue Service and the U.S. Treasury Department issued proposed regulations regarding Opportunity Zones designed to encourage economic development by providing tax benefits to individuals who invest money into projects that are located in certain designated districts. The regulations are not yet final and are subject to change, but according to the recently proposed regulations, investors may be able to defer capital-gains taxes for 10 years on prior investments if the gains are transferred to Opportunity Zone investments and certain other conditions are met.

Delegate Advisors President and Chief Advisor Andy Hart recently spoke with American Banker to provide insights on the specific advantages of these investments. In the article, Hart describes how Opportunity Zone investments can be extremely appealing to individuals who are interested in avoiding a huge tax bill on a corporate stock that has skyrocketed in value. “For a person who’s got a gain in a highly appreciated tech stock, they’re going to look for Opportunity Zone investments,” states Hart.

Hart goes onto to explain that tax cuts introduced by the 2017 Tax Cuts and Jobs Act have not lessened the appeal of other types of tax benefits. Even with the federal tax cuts, individuals are still searching for other ways to minimize capital gains taxes. Because Opportunity Zone investments may enable capital gains taxes to be deferred for close to a decade and possess the potential to increase in value, it is no surprise that these investments could become an attractive option for investors. 

Subscribers to American Banker can read the entire article here.

Andy Hart in ThinkAdvisor: Opportunity Zone Funds Are Coming to Market

ThinkAdvisor recently featured Delegate Advisors President and Chief Advisor Andy Hart in an article about Opportunity Zone funds. In the piece, Hart describes how Opportunity Zone funds might attract investors who are sitting on gains of highly appreciated assets, such as tech stocks, and want the ability to defer taxes on those gains. Because the final rules and regulations regarding Opportunity Zones have not yet been finalized, most funds attempting to capitalize on them have not yet come to market. We anticipate that, once the rules and regulations are final, fund managers will begin aggressively marketing investment options.

Opportunity Zones are often high-need communities selected by states and are located throughout the U.S. Thus, Opportunity Zone funds not only have the potential to provide tax benefits for investors, but also the potential to create positive impacts on low-income communities.

In fact, Opportunity Zone funds might become a viable option for investors with capital gains, a long time horizon, and a desire to make socially responsible investments. With Opportunity Zone funds, investors can receive certain tax benefits with respect to their capital gains as long as they reinvest their gains into a fund that places a defined proportion of its assets into a business located in an Opportunity Zone.

Investments in Opportunity Zones, however, are not a guaranteed success. Rather, these investments are “potentially great but they have to be a good investment to begin with,” explains Hart. “If it happens to be in an opportunity zone, we would look to rebalance a client’s portfolio to generate gains and then invest in a fund. We focus first on the investment side, not the taxes.”

Find ThinkAdvisor’s entire Opportunity Zone funds article here.

Delegate Advisors Receives Award from The Family Wealth Alliance

We are pleased to announce that Delegate Advisors has won the Best in the Industry Award in the category of Boutique Multifamily Office (Firm) from The Family Wealth Alliance.

The Family Wealth Alliance, commonly referred to as “The Alliance,” frequently provides thought leadership on both trends and developments in the industry.  According to Thomas R. Livergood, Founder and CEO of The Alliance, “Because of the role The Alliance plays within the family wealth industry, we have enjoyed a unique vantage point from which to identify the trailblazers among us.” 

Delegate Advisors received this honor from The Family Wealth Alliance during its Anniversary Awards Gala. Held in partnership with The Alliance’s Fall Forum, this year’s gala included 165 industry leaders in attendance as winners of 18 prestigious Best in the Industry Awards were presented.  

The winners of each category were determined by a judges panel. “We received more than 100 nominations for this year’s awards, and our judges had an extremely difficult time choosing the category winners,” explains Livergood. But despite the competition, Livergood adds, “each finalist deserved to win, as the businesses represented were truly best in class in so many ways.”

The judging criteria for The Family Wealth Alliance’s Best in the Industry Award for Boutique Multifamily Office (Firm) consisted of the following: A firm with $5 billion or less in assets under management that has demonstrated impressive leadership in terms of marketplace differentiation, exemplary service, successful client outcomes, and excellent management.

“Winning this year’s Best in the Industry Award for Boutique Multifamily Office (Firm) from The Family Wealth Alliance is a great honor,” comments Delegate Advisors President and Chief Advisor Andy Hart. “Our special team at Delegate Advisors is extremely committed to always putting our clients first. We feel so rewarded to have our determination recognized by other professionals in the family wealth industry.”

View the full list of categories and winners of this year’s Best in the Industry Awards here.


The Global Financial Crisis: Ten Years Later

September 15, 2018, marked the tenth anniversary of what many consider the key event of the global financial crisis (“GFC”): the fall of the venerable Wall Street firm, Lehman Brothers. On this tenth anniversary, our quarterly letter will touch on some root causes of the crisis, how certain issues related to it echo through capital markets today and, finally, what this means for Delegate clients. While we will discuss many aspects of the GFC in this letter, we recommend the following sources for a more complete retrospective of the 2008-2009 period, when the world teetered on the precipice of total economic collapse:

At a high level, two primary causes of the GFC were poor underwriting of mortgages and a long period of deregulation. As home prices began to rise in certain parts of the country (e.g., South Florida, Las Vegas), lenders loosened underwriting standards to almost comically low levels under the false belief that home prices would always remain high. The resulting toxic mortgages were packaged together in often highly leveraged, illiquid structures and held by, in many cases, depository banking institutions and investment banks. When home prices crashed and these structures collapsed, the investment banks’ capital (e.g., Bear Stearns, Lehman) immediately dried up and “mom and pop” began to fear that they would not be able to withdraw from their local bank because it had invested their deposits into these toxic structures. This occurred against a backdrop of an almost 30-year period of capital market expansion and deregulation beginning with the savings and loan crisis of the mid-1980s, a small-scale prototype for the GFC. Lessons that markets and investors learned as a result of that crisis were apparently forgotten. 

Since the GFC and until very recently, the regulatory pendulum has swung in the opposite direction, toward more regulation rather than increased deregulation. The Basel Accords III and the Dodd-Frank Act were attempts to rein in many of the practices that caused the GFC and strengthen banks’ capital requirements to prevent future insolvency.

These new regulations caused a boom in the “shadow banking” industry, which sounds nefarious but is really just the business of private lending outside of the banking system. Since the GFC, as illustrated below, global private direct lending assets under management has increased from $39 billion to $181 billion, a 4.6x increase over an eight-year period.

Source: Preqin.

Source: Preqin.

This shift is generally thought of as a positive effect of the GFC, because the riskier loans are now knowingly held by sophisticated investors (e.g., pension funds, endowments, ultra-high net worth families), rather than by depository institutions who used “mom and pop” deposits to fund suspect investments. 

While the growth of private lending is an encouraging sign, the explosive growth of public high-yield “junk” and bonds rated BBB has created the potential for future distress. 

As shown below, the size of the domestic corporate high-yield market has tripled since 2009. Not only has the size of the market grown drastically, lenders have increasingly agreed to relaxed covenants, which limit their ability to monitor borrowers and to take action if necessary to limit the risk of a default. 

Source: Bloomberg.

Source: Bloomberg.

While BBB-rated debt is still considered investment grade, it is the lowest-rated class of investment grade bonds. Since 2008, the total value of the investment grade market has grown from $4.8 trillion to $9.3 trillion. In 2000, BBB-rated debt comprised about 20% of the investment grade market ($1.2T). Now, BBB rated debt comprises over half of the investment grade market ($4.8T). The primary reason for the growth in both high-yield and BBB-rated debt is that investors, facing historically low interest rates, are searching for yield in increasingly higher-risk investments. If there is a troubling sign for the current economy, this is it. While “mom and pop” are somewhat more insulated from risk with their cash at the bank than ten years ago, retirement accounts might be invested in riskier investments than they realize. Additionally, many of these risky investments are packaged in increasingly popular ETFs and mutual funds that offer overnight liquidity and so are obligated to sell when they get redemption requests, regardless of whether it is prudent to do so. 

Source: SIFMA.

Source: SIFMA.

In summary, while private debt investments are protected by lock-ups that prevent the need for “forced selling”, public investments in ETFs that hold risky debt would likely become stressed in a credit or liquidity event similar to what occurred during the GFC. To mitigate against this risk, we have generally advised clients to reduce high yield exposure to zero. 

So what does all this mean for a Delegate client? We believe the three most important lessons for investors coming out of the GFC are:

  • Don’t panic.
    Investors who panicked and sold at the worst time (early-2009) have missed out on a historic bull market in US equities. We repeatedly, for good reason, look to Warren Buffett’s simple advice in times of stress to be “fearful when others are greedy and greedy when others are fearful.” 

  • Use long-term planning to avoid getting into a liquidity bind.
    At Delegate, we treat each client like their own financial system and project their cash needs far out into the future to determine how much cash and short-term, liquid investments to hold in case the economy’s gears grind to a halt. 

  • Have a plan in the event of a crisis.
    Work with a trusted advisor to understand what would cause personal stress in such an event, and establish a plan to mitigate that stress. Create an investment plan designed to be opportunistic in a crisis, capitalizing on fear and market dislocations. The best time to establish a crisis plan is when there’s not a crisis (i.e., now).

The good news is that we do not see signs of an impending crisis in the near term. We see where we believe it might manifest if we had one (e.g., high yield credit or dollar-denominated emerging market debt), but we do not currently see a catalyst to trigger the “next” GFC. If a crisis begins to emerge, it will likely not be as catastrophic as the last one. To safeguard against a shock, however, we have been advising clients to begin to:

  • Build cash positions to above policy targets

  • Maintain short duration, high-quality fixed income portfolios

  • Reduce equity positions to neutral or slightly underweight versus policy targets

While economic activity is expected to remain strong, financial assets may struggle to generate compelling absolute returns due to high current valuations and the fading effects of fiscal and monetary stimulus. With the still-present tailwinds of the corporate tax cut driving earnings ever higher and the continuing expansion of corporate stock buyback programs providing price support for equities, however, this economy has positive momentum that we believe can take it well into 2019.

The Bull Market Shows Its Age

In the third quarter, domestic equity market values continued to increase, reaching new, all-time highs. The strong performance was driven by the ongoing results of last year’s tax cuts, which have boosted corporate profits throughout the year. Markets continue to discount potential bad news, notably, signs of a trade war brewing with several of the United States’ largest trade partners. While an outright trade war would certainly be a negative for the global economy, markets seem to believe that a neutral or even positive outcome is more likely in the form of renegotiated trade agreements. For example, the U.S., Mexico and Canada recently agreed on a renegotiated NAFTA, with Canada seemingly capitulating to the U.S.’s aggressive negotiating tactics. A renegotiation of trade terms with Europe is likely next up, with China looming. 

As the quarter turned, however, global equities sold off quickly and deeply, with markets showing signs that the decade-long bull market may be nearing an end. The end of bull market expansions is typically marked by several run-ups to record highs and “corrections” before capitulation to an inevitable recession. In times like these, we remind our clients that long-term investors should be less concerned with daily volatility and that investment returns should be measured over an economic cycle (i.e., 8-10 years). In this regard, we are generally advising clients to reduce public equity exposure to the low end of policy ranges, and to tilt equity exposure toward value over growth. As illustrated below, domestic value stocks have underperformed growth over the last ten years. This will likely reverse over the next phase of the market cycle, as growth stocks tend to outperform in bull markets, while value outperforms in bear markets. 

Source: Bloomberg.

Source: Bloomberg.