Fidelity's Ilan Kolet: The biggest questions for 2024

Full Transcript

[00:00:00] Pierre Daillie: Welcome back. I’m Pierre Daillie, Managing Editor at AdvisorAnalyst.Com. And this is Insight is Capital. Ilan Kolet, Institutional Portfolio Manager in Fidelity’s Global Asset Allocation Team is here to talk about the questions he and his colleagues, David Wolf and David Tulk have been fielding most frequently from advisors and investors at the start of 2024.

[00:00:23] Dislaimer: this is the Insight is Capital podcast.

[00:00:29] Ilan Kolet: The views and opinions expressed in this broadcast are those of the individual guests and do not necessarily reflect the official policy or position of AdvisorAnalyst. com or of our guests. This broadcast is meant to be for informational purposes only. Nothing discussed in this broadcast is intended to be considered as advice.

[00:00:42] Pierre Daillie: Ilan, welcome back. Happy New Year.

[00:00:45] Ilan Kolet: Thanks very much, Pierre. It’s, uh, as always, it was a really enjoyable conversation last time and, um, and looking forward to having another great discussion to start out 2024. It’s

[00:00:54] Pierre Daillie: great to have you. It’s only been a little over a month since we last spoke, and yet [00:01:00] so much has transpired since.

[00:01:02] Uh, Chair Powell’s about face for starters.

[00:01:05] Ilan Kolet: Yeah, I, you know, I mean, there’s been a meaningful change, I think, to the expected path of monetary policy for us. I would say. The conviction in that is quite high in the U. S. Um, it’s led to a material change. It’s led, I should say in parts to a material change in positioning around around the U. S. And the optimism in the U. S. The fundamental fact remains that for us, a high conviction view is the U. S. Is going to outperform this year. And that’s and monetary policy doesn’t need to be as restrictive as it’s been for the last few years.

[00:01:40] Pierre Daillie: It was kind of a weird period because the, I mean, it was very anticlimactic.

[00:01:44] It happened very quickly. The market very quickly priced in six, six, um, rate cuts while the Fed has telegraphed only three. So, so, you know, what gives, uh, with that is the market, right? Or have we gotten out? Have we gotten out over our skis? [00:02:00]

[00:02:00] Ilan Kolet: Yeah. You know, so the way I think about this, I mean, maybe this is a.

[00:02:05] A tough one to make as our first discussion point, but is we don’t know, right? So investors don’t know. And honestly, neither does the Fed or the Bank of Canada, right? So what do we know? I mean, that’s kind of a useless answer. So what do we know? We know that with the significant improvement in underlying inflation in the U.

[00:02:25] S. Coupled with the slow rise and slight drift higher in the unemployment rate rates, don’t policy rates. Monetary policy does not need to be as restrictive as it’s been. Um, and. I think the Fed, I mean, they probably won’t, uh, won’t admit this, uh, too rapidly, but the Fed was late to liftoff. I don’t think they want to be late to nor rate normalization.

[00:02:52] And so, and so what I mean by that is, you know, rates, like there were 525 basis points of rate hikes in the U. S. So let’s say we’re [00:03:00] at around 5. The Fed moving from 5 to 4 or 5 to the high 3s. Is is then becoming less restrictive, right? That’s not a reactionary cut to a spiking unemployment rate or growth falling off a cliff.

[00:03:14] That’s the feds. That’s the fed recognizing and being data dependent, as they’ve said, and recognizing, look, the six month annualized rate of core PCE inflation is 1. 9%. I mean, the unemployment rate has drifted higher. The labor market is less tight. We’re seeing progress on inflation. Rates don’t need to be as restrictive because If we keep things restricted with this improvement, uh, the longer you’re restrictive, the more restrictive you are, and you run the risk of sort of squishing the consumer, the housing market, business investment, and maybe this little productivity boom that we think we’re in the midst of.

[00:03:52] In the U. S. Um, so rate cuts are the right move and again, anyone who has precision around specific dates or by [00:04:00] how much or where the landing point is, I would really fade all of those sort of, um, talking heads about specifics on, on rate cuts. The truth is the Fed doesn’t actually know. Where the, where the landing point will be, or, or the cumulative amount of rate cuts that we’ll see in 2024.

[00:04:18] Pierre Daillie: Yeah, so, I mean, in a way, they’ve definitively called, uh, a pause. Uh, they, they, they’ve sort of, it seems like they’ve definitively, you know, brought up the subject of taking their foot off the brake, maybe, uh, as, as well. And, and that we’ll have these rate cuts at some point in, in 24. Um. There’s also some concern.

[00:04:41] I mean, it creates, uh, I mean, the uncertainty hasn’t gone away, right? And, and so, you know, if anything, um, you know, some, some voices in market are talking about, you know, inflation volatility, that taking the foot off the brake could actually, [00:05:00] um, you know, cause a surge, a surge, a resurgence. Uh, rather in, in inflation or inflationary pressures, uh, in certain quadrants of the economy.

[00:05:10] Um, And given that, I think, you know, one of the, the, the first question in your white paper that you recently released, uh, this past week was, you know, the case for making, for, for why investors should consider, uh, you know, balanced mandates or, uh, asset allocation funds, tactical asset allocation strategies, uh, in this market, rather than taking a, uh, seat at the sidelines.

[00:05:39] Uh, in cash instruments or G. I. C. S. So, um, why, why would you stress at this point favoring balanced or asset allocation mandates, uh, at this time versus just taking, you know, the easy five or 6 percent that’s available, uh, at the [00:06:00] bank or in the market, uh, through T bills.

[00:06:02] Ilan Kolet: Yeah. So, so Pierre, the reason this was question one in this 11 questions for 2024 paper is because it’s the question that I answered, I don’t know, 8000 times a week last year. Um, and that every, you know, and that every advisor who’s listening to this call, uh, answered a lot of questions around this and, you know, investors flocked it naturally. To G. I. C. S.

[00:06:26] Because they got rates of returns that they hadn’t seen in decades. So it’s

[00:06:30] Pierre Daillie: sure it’s the easy. It’s the easy low hanging fruit. I don’t have to take any risk. I can just get this risk free rate of 4, 5, 6 percent

[00:06:39] Ilan Kolet: exactly. Yeah, exactly. And so. Um,

[00:06:44] Pierre Daillie: it’s not hard to understand, right? I mean, it’s risk aversion sets in after, after, you know, uh, one and a half to two years of pretty rough markets, um, you know, and, and, and unpredictable, you know, missing the rally, for example, at the beginning of the [00:07:00] year, uh, was something that, that upset a lot of people, uh, you know, quietly upset them.

[00:07:06] Ilan Kolet: Right. Right. I mean, I think the combination of 2022, right? So 2022 from a stock bond environment because of elevated inflation and inflation volatility was, and we discussed this in the past was sort of down and downer, right? So the combination of the bad taste in the mouth of 2022 coupled with historically elevated guaranteed rates of return led to all sorts of investors, not just the risk averse ones.

[00:07:35] You know, plowing into GICs and, and, uh, those types of term investments. And for the downside protected, uh, investor, um, it’s a natural decision to make, right? Especially if you have some excellent excess liquidity and you just want to park uncertainty and park capital, the argument that we make in the paper in question one, um, is around the [00:08:00] longer, uh, trade off between risk and return.

[00:08:03] Right. And so. Um, in, in the first paper, in, in the, in the first question, in the first paper, we have a chart showing, you know, your experience over the past 10 years in a, in a GIC, 1, 000 in a GIC over the last 10 years is just over 1, 100, um, at the end of 2023, and it’s 1, 900 if you’re, if you were in our global balanced managed portfolio, a globally diversified 6040 with great underlying managers and us leaning in or out of Asset classes, styles, sectors, and currencies.

[00:08:36] Now. It feels a little silly at times to compare a G. I. C. to a 60 40 stock bond, multi asset class fund that’s globally diversified. So the other thing we did is we said, what if you had? What if you had had? What if the investor, the Canadian investor had had a 5 percent G. I. C. every single year for the past 10 years?

[00:08:58] So again, this is a purely hypothetical [00:09:00] case. Um, and even then that is 1600 versus the almost 2000 that A thousand dollars would have become in, in, in our funds. And then the second chart that we show, which is again, a little bit nerdier as a scatterplot. I mean, you know, as a nerd, I, there’s nothing I love more than a good scatterplot.

[00:09:19] Um, and that scatterplot just shows that risk and return trade off between again, all equity, all bonds, uh, GIC, and then various multi asset class funds. So again, for the medium to long term investor, I think, uh, a well diversified multi asset class fund makes the right sense. I’m sympathetic. I’m completely sympathetic to the, to the investor that, you know, suffered in 2022 that wanted safety that wanted to park capital, um, and put money into a G.

[00:09:51] I. C. I think what’s interesting now for advisors and this has come up. Um, this came up in recent conversations throughout Ontario and BC [00:10:00] is those, some of those GICs for client, for advisors, clients are now maturing. Where’s the next step? What’s the next step? Um, and that’s, I think the, the interesting conversation and where this question one in this paper will be really, really helpful in exploring those options for the, for the medium to long term.

[00:10:18] Pierre Daillie: Right. Yeah. I mean, given that, that, uh, you know, you’re, you’re like, we’ve got all these biases that we have to constantly. Uh, contend with, right, we have to contend with ourselves and our inability to make the right decisions at the right moment at exactly the right moments and that’s the danger of, of being invested or uninvested, um, you know, either way you’re, you’re taking, you’re taking the risk, uh, you know, with, with GICs, with paper, uh, you know, cash, it’s, it’s three investment risk, right?

[00:10:50] It’s, it’s, it’s that, that by the time, um, You reach the decision making point, you might have, um, you know, you might find yourself [00:11:00] facing lower rates and then, uh, the dilemma of also missing out on, on the, the positives that are happening in both the bond market and the equity market as a result of falling rates.

[00:11:12] And so you don’t want to be, you don’t want to position yourself out. Of, of the market, but you want to, you want, you, you want to position yourself in a way to continue to participate and, and, and also not find yourself at that, at that intersection where you have to make a decision about reinvesting and then not knowing what to do once again.

[00:11:31] Uh, like, you know, that, that, that turn of the year at the beginning of 24, when, you know, the magnificent seven began to rally. And, uh, you know, if you were in us equity exposure, uh, you would have caught that. But if you had been risk averse because of the previous, you know, previous year’s business, uh, activity in the market, um, you would have completely missed it.

[00:11:56] And by the time you realized, oh, you know, I gotta, I gotta, I gotta [00:12:00] turn things around in my portfolio or turn things over, uh, you know, you start to feel that, that angst of, uh, missing out, right? Uh, having missed out as opposed to FOMO.

[00:12:12] Ilan Kolet: Right. I mean, I think advisors. One of the very difficult jobs that advisors have are those difficult conversations around various life events.

[00:12:21] I’m sure those are exceptionally difficult, but the last couple of years, I’m really sympathetic to the advisors that I speak to and reach and reach out to, and that we help in terms of such the oddity of the market, right? So, the, the covid shock, the, the resulting inflation shock, the destruction or, or, um, erosion of stock bond correlations, right?

[00:12:43] So, we’ve been in a. It’s been a very, very tricky time, which for the advisors who are listening, shows up as really, really difficult conversations. Um, and, and so this paper, I think, really attempts to help advisors sort of arm them with, with, [00:13:00] uh, some, some techniques or some questions to, to engage in these difficult conversations.

[00:13:05] The other thing I mentioned, Pierre, is We also, in our multi asset class funds, have access to cash like instruments, right? So the short term allocations in our funds, um, you know, I kind of think about those as, that’s, that’s what we call cash. I mean, that, that has access to that yield pickup. Right. That was one of the large overweights that we had in 2022.

[00:13:29] We had a high conviction view that short term rates were going to move higher. We had 8 or 9 percent of our 60 40 sitting in cash, which again is uncharacteristic. I mean, investors buy our funds to be fully invested, not to hold 9 percent of it in cash, but we held a large share of it in cash because. It was a sensible thing to do.

[00:13:48] So that, there’s some similarities there to that GIC motivation. I think we’ve moved away and out of that environment now. Um, and to, and again, I mean, we were discussing this before, [00:14:00] but we’re outright optimistic on the U S I’m excited about what we’re seeing in the U S um, it’s almost uncharacteristic for me to sound this positive.

[00:14:07] I think my family’s a little bit thrown off, but, uh, but again, there are some exciting things happening right now, I think in the U S and we’re taking advantage of that with. Um, tactical overweights to U. S. equities.

[00:14:20] Pierre Daillie: I think I, I just wanted to recap something that you said in our last conversation, which I thought was one of the highlights of the entire conversation, because I mean, at least for me, it was an insight.

[00:14:29] And that was the fact that, that you said that inflation, uh, these bouts of inflation. What’s particularly dangerous about them is that is the way in which they affect the correlation between stocks and bonds or erode the, the, uh, you know, the correlation, uh, you know, where everything has a correlation of one.

[00:14:50] And, and, um, I thought that was actually one of the, uh, great insights of our last conversation. I’d never heard that before. I’d never heard, I mean, it’s been [00:15:00] so long since we had inflation, but I had never. Uh, heard it put quite that way and I just wanted to, uh, uh, you know, um, give you a nod. Yeah. No,

[00:15:11] Ilan Kolet: I think, so again, like, I’ve spent, I don’t know, more than 20 years thinking about inflation when I, from the time I started at the Bank of Canada, um, to my time at Bloomberg News to being the head of inflation and commodities research down in Boston on our asset allocation research team. A lot of the times when I’m talking to advisors and, and institutional investors.

[00:15:35] You know, I think we have to move past this notion of inflation. And I don’t want to diminish it. We know that inflation erodes the purchasing power of every dollar we have, right? So if, if grocery prices are up 20 percent and eating out is up 20 percent and used cars are up 40 percent and our wage has gone up 10 or 12%, we’re worse off.

[00:15:55] I think we all understand that. The reason we care, we should really care as [00:16:00] investors, right? So investors listening and, and, and the investors that I speak to is because of what it does to that. Stock and bond correlation, again, in, in the multi asset class strategies, like this is a founding principle to the stock bond mix, right?

[00:16:16] That, that we all know and love. And one of the things I can’t remember if I mentioned this last time, but I used to talk about it and I have, I had a chart showing the 1970s, right? So if you sat, if you were in a 60, 40 in the 1970s. I mean, you had kind of a lost decade from, uh, from a rolling return perspective because it was again down and downer unless you own the land that produce the commodity or, you know, had a bunch of commodities sitting in your basement that they were uninvestable.

[00:16:46] It was it was a terrible period and that was not that was because that. elevated rate of inflation had eroded that stock bond correlation. So I used to talk about the 70s as a great example of that, but now I talk about 2022 [00:17:00] as a great example of that, right? So there’s been some improvement there, but, um, but no, that’s the reason we should care as investors.

[00:17:07] And, uh, and it’s. It’s a really important point and one we protected against, but again, right in 2022, we protected against it and we preserved basis points from a relative perspective, but preserving basis points from a relative perspective. I have learned. Is not the way that advisors, clients think about their portfolios, right?

[00:17:27] They see, they see red on the statement. They don’t see less red than the benchmarks. Right. So I’m, again, I’m sympathetic to those conversations, those hard conversations that advisors are having. Yeah.

[00:17:39] Pierre Daillie: So Ilan, I think you, you already touched on your, your highest conviction or overweights, but. Talk about those high conviction overweights that are, that was, uh, the next question, uh, one of the, I mean, the next two questions are, are, what are, you know, what are your highest conviction overweights and what are your, what are your, um, highest conviction [00:18:00] underweights?

[00:18:01] Um, so maybe, maybe, uh, talk about that as, as, as we enter this year.

[00:18:07] Ilan Kolet: Yeah, I mean, maybe I’ll do the, the, the underweight one first, and then I’ll pivot to the positive one. So we. Kind of end the question on a positive note, but, um, so we still have, you know, meaningful concern around Canada. We think that exceptionally high rates of household debt intersecting higher borrowing rates, even if the bank cuts in the back half of this year, right, mortgages are not going to be renewing at rates that people were getting pre COVID.

[00:18:35] Um, we think that’s going to, you know, spell some, some trouble or some problems for the Canadian macro economy. And we think that’s going to show up as underperformance, relative underperformance in Canadian equities, right? So our. Our highest conviction underweight right now, again, is around Canada. Um, and there’s a few, a few points I really should make on that, um, just to clarify things.

[00:18:57] So we’re underweight [00:19:00] Canada, uh, Canadian equities, Canadian fixed income. We’re meaningfully underweight the Canadian dollar, um, because we think it’s one of the first valves that we’ll get. Uh, the pressure release valves that will get released in the event of this stress actually, um, showing up in headlines and sentiment, right, we’d see a depreciation of the Canadian dollar.

[00:19:19] If we’re underweight to Canadian dollar, our portfolios get hurt less. Um, and so in the paper, one of the things we talk about though, is it’s kind of interesting. We do this look on a look through basis. So we’re underweight Canadian equities. If you look through the, to the underlying managers that we’re using in Canada, they’re underweight the Canadian banks, right?

[00:19:42] And so, which is a very, uh, sort of contentious or controversial thing to talk about because for many, many Canadian portfolios, Canadian investors, Canadian advisors, Canadian banks have been the cornerstone of those portfolios for 20 years. What I would say is, and we get into this in the paper is [00:20:00] Canadian banks have done well, I think unsurprisingly in.

[00:20:04] a credit and housing boom, right? So where has Canada been for the last 20 or 25 years in this giant, expanding, overtaking credit and housing boom? And it’s unsurprising that the lenders of those mortgages have done well, right? And so I think, I think that’s an interesting, right? That’s an interesting perspective.

[00:20:23] The thing, the one nuance I would make here, I would, I would, I would clarify here, and this is something I don’t think I did a good enough job on when we spoke last time, or even in some of my previous conversations, is even if Canada underperforms, say, the U. S., if the underlying managers that we use in our strategies outperform their benchmarks, right?

[00:20:47] So they choose bank A instead of bank B, or resource company A instead of resource company B, and they beat their individual benchmarks, we still win, right? So, like we, again, we [00:21:00] talked about this in our last conversation, there are really two layers, right? So hire a great team, use a great team of underlying managers and let them follow their research process to beat their benchmarks.

[00:21:13] And if we own them, they, they boost us. And then the other thing, which is, which will link to the, to our highest conviction overweight is lean in or out of asset allocation, uh, sectors or geographies to add value as well. And that sort of brings us to that highest conviction overweight and optimism, which is around the U S right.

[00:21:32] So in the paper, we talk about it. as an overweight to the U. S. dollar. Um, but really, I think, you know, the most meaningful change now versus the last time we spoke, Pierre, I think the last time we spoke, I probably said we’re roughly neutral beta, right? So we’re, the 60, 40s are sitting very close to 60 and 40.

[00:21:52] We’re now overweight equities, and that is entirely, almost entirely because of a change in view, uh, around the U. [00:22:00] S. So the last time we spoke, we were underweight U. S. equities. We’re now outright overweight, the U. S. Uh, U. S. equities and that change in view is motivated, is always going to be research motivated, but it’s motivated, I think, from two main areas.

[00:22:17] The first is, um, the increased likelihood of a soft landing in the U. S., right? So I, we probably talked about this last time. I might have hinted at it, but, um, the likelihood that the U. S. achieves a soft, achieves a soft landing. Has materially increased and is now my base case. Uh, and again, I can almost feel the collective eye roll from everyone listening right now.

[00:22:40] Um, and, and most folks are probably too polite to do that. But, um, again, with 525 basis points of tightening in the U S it would be pretty unusual and rare to achieve a soft landing. But I think the soft landing will be achieved for, for two reasons. The first is, [00:23:00] uh, The U. S. is less interest rate sensitive than it’s been in a long time, perhaps ever, and that’s because, uh, rates of, um, levels of household debt are lower, right, than they were, say, pre financial crisis.

[00:23:14] Um, and A tremendous portion of American homeowners refinance their mortgage pre covid again. We probably talked about this, but, you know, when I lived in Boston, 2014 to the middle of 21, I had a fixed rate mortgage for 30 years. That was 2 percent and everybody on my street refinance their, their mortgage pre covid.

[00:23:36] And I knew this because they knew I was an economist after dinner. I’d walk the dog and over 11, 12 months period. Everyone asked me. is now the time to refinance my mortgage. So I would take out my phone, open the very useful St. Louis Federal Reserve app, which maybe I’m the only one who has that downloaded, and show them the chart and show them the chart on the 30 year conventional mortgage [00:24:00] that’s a straight line down and ask them, how much lower do you want this to get?

[00:24:04] So that’s the first point.,

[00:24:05] Pierre Daillie: I think for Canadians, that would be like a dream scenario, you know, to have a 30 year, a 30 year mortgage fixed at 2 percent would be like, you what?

[00:24:16] Ilan Kolet: Yeah. Yeah. And another thing we talked about here last time was this wonderful perk of, um, mortgage interest costs deductibility, right? Which is like, it’s a gift.

[00:24:27] It’s a little perk and a gift. And it’s not little actually. It’s a, it’s a pretty meaningful perk. So the first one, …

[00:24:34] Pierre Daillie: it covers half of your payment. I mean. Yeah, it’s um. Right, it covers half of your interest basically. Yeah, it’s uh. If you’re in the, if you’re in the highest bracket, you, you know, you’re, you’re gonna, you’re gonna get that back and, and put that towards your mortgage.

[00:24:47] Ilan Kolet: Right. You know, it’s uh, yeah, it, it, it’s, it’s a real, it’s a strange one, right? Because it’s a perk for homeowners who already are at the income spectrum or part of the income spectrum that can afford housing. It’s very contentious. There’s been a [00:25:00] lot of research on it. Sorry, not very contentious, it, there’s been a lot of research on it around the equitable results of that.

[00:25:06] Yeah. But you’re absolutely right. It’s a, it’s a perk, but the interest rate sensitivity one is the first reason we’re overweight and optimistic on the U. S. The second one is actually something that I’m really excited about and it’s the likelihood that the U. S. is in the midst of a product, a little productivity boom or a product recycle.

[00:25:25] And so, you know, you can imagine, imagine advances in artificial intelligence or investments in clean technology or, or, or households and workers optimizing their work life balance a little bit better, has led to an increase in the stall speed or the potential growth rate of the U. S. economy. If that’s the case, then Inflation can continue to fall like it has been, again, six month annualized rate of core PCE is 1.

[00:25:57] 9, the labor market can remain [00:26:00] at historic lows, earnings can do well, equities can do well, um, and the U. S. can do exceptionally well, so it’s like a checklist on the optimistic bullish scenario for the U. S. Um. And something that I think is, is very plausible and a motivation for why we’re overweight U. S. equities right now. Um, I mean, it’s a, it’s a pretty great, pretty great scenario. And, and, and again, there’s some eye rolling happening right now. I can feel it. Uh, this has actually happened in the past, right? So in the mid to late 90s. We had the advent of the Internet, it changed business processes really significantly, the recession models that we were using in the mid to late 90s were flashing red, similar to the ones that we have now, uh, but we never got that recession because the stall speed the U. S. was just that much higher, right? And it was a, if we all remember mid to late nineties, it was a pretty great time, right? For earnings and equities.

[00:26:59] Pierre Daillie: I, [00:27:00] um, you know, I recall, I recall listening to Ken Griffin in, in, in one of his appearances on. Bloomberg talking about how, I mean, he was asked, what do you think is the, uh, you know, what do you think is one of the most misunderstood, basically when one of the most misunderstood aspects of the market right now.

[00:27:18] And, and, um, you know, his, his response was, was a surprise at the moment because 6040 investors, uh, had basically gotten pummeled for the last couple of years. And, and he turned around and he said, he said, now is actually a really good time in, in, in the market for 6040. And, and, you know, he basically, all he did was he flipped the script, right?

[00:27:42] He just turned everything that people were feeling upside down and into an opportunity. But he was, you know, looking back on, on that, that flipping of the script, he was, he was quite right. And, and, uh, it was, it was, it was, you know, anybody who sort of, you know, glommed onto that idea, [00:28:00] it was quite a fortuitous moment.

[00:28:02] As well, uh, to, to have heard that and, and, and it’s another thing to act on it, given how we felt. Um, but I, I’m curious, you know, after we’ve had this very sort of rough period for the bond market because of these 525, you know, points in rate hikes, is this the comeback year for bonds?

[00:28:22] Ilan Kolet: Yeah. So again, I always think about things Pierre, as you know, in the context of monetary policy.

[00:28:28] The Fed and the Bank of Canada. I mean, I do think we’re certainly at the end of rate hikes. I think the likelihood of a push higher in rates is very, very low. And again, I’m just, I’m looking at exactly the same data that everyone who’s listening right now is looking at, which is the same data set that the Fed and the Bank of Canada are looking at, right?

[00:28:47] There’s no magical data set that we don’t have that they have. Um, and so the likelihood of Rate cuts this year again is quite high, uh, we don’t know cumulatively, cumulatively by how much. What we’ve done in the funds is we’ve, [00:29:00] we’re basically neutral in terms of duration right now. Um. We, we think the better place for really to, for us to enhance, uh, the return, the expected return of our funds is being opportunistic in some parts of the equity market.

[00:29:16] Um, and on the bond side, again, we’ve pulled in some of the underweights to, to investment grade debt, but we remain overweight, uh, on the credit and the spread sectors, right? So the leveraged loans, the high yield, the global high yield. These are areas where we continue to be overweight, um, and, and where we think we can enhance the income side of the portfolio.

[00:29:37] That said, again, I, um, I think what it would take for us to really change our, our position and our view on, on duration is a return to a more normal correlation environment, number one. And number two, you know, we need to be a little bit closer to the actual normalization in monetary policy. Um, again, [00:30:00] And this is going to be a bit nerdy, but if we’re at five right now, I mean, surprise, surprise, right?

[00:30:05] Yeah. If we’re at five right now and neutral is two and a half, there’s a tremendous amount of, uh, of way to go of runway for rate cuts. If that said, and that explains some of the, um, some of that sort of exuberance that, that bond managers and bond investors are thinking about, wow, we’re at five and we have to get to two and a half.

[00:30:26] That’s, that’s hugely optimistic. If. The productivity growth and potential growth story that I just outlined in our previous discussion in the previous question. is actually happening. The trick with that is it means that neutral is not in the low twos, right? Or two and a half. It could mean that neutral is in the low threes, which means the gap between where we are now and neutral is a little bit smaller, which, which allows us or makes us think maybe we should pump the brakes a little bit on that, um, on that bond optimism, right?

[00:30:59] [00:31:00] So this is something again, that we answer in this paper, thinking more holistically in terms of the full fund. Uh, and, and again, our overweights will reflect conviction. This conviction in, in the overweight to equities specifically in the U. S. is, is sort of front and center for us right now.

[00:31:18] Pierre Daillie: You know, just, just reflecting on, you know, the way that you’re going about, um, managing the, your asset allocation strategies, your asset allocation mandates at Fidelity.

[00:31:32] It’s interesting to point out that. That, you know, while you have a negative or, or a less optimistic view rather on Canada, you’re not divesting Canada. You’re, you’re just investing less relatively relative to the other opportunities that are out there.

[00:31:49] Ilan Kolet: That’s probably the, one of the most important takeaways from our conversation today and something again, that I think is easy to get lost when we talk about caution in Canada, you’re, you’re bang on with that point, [00:32:00] right?

[00:32:00] So the 60, 40 that we manage the global balance, 60, 40. 21 percent of the equities in that, in the 60 are Canada, we’re just shaving it by 7 percent because we think there are, there’s going to be relative outperformance in other areas of the world or markets, uh, versus Canada. But exactly like you mentioned, Pierre, those underlying managers that we’re using in the Canadian sleeve.

[00:32:26] Of our Canadian equities in our funds, if they beat their benchmarks again, which historically they do, they boost the performance, the overall performance of the fund. That’s a very, very important point that again, I think sometimes I, I guess it gets a little bit lost because we’re talking, you know, we’re talking about this three dimensional matrix, uh, which is sometimes difficult to explain.

[00:32:49] Pierre Daillie: Well, and, and, you know, and the role of advisors is, is very challenging because Of expectations that clients have of the advisor and, and vice versa, [00:33:00] getting, you know, advisors, a challenge of getting the client on board with any idea. And, um, especially, you know, in the, in the midst of risk aversion that we’ve had through the last couple of years, inflation.

[00:33:12] I think the benefit of being in a, in a, like in a single ticket type of situation where your whole portfolio, you know, an entire portfolio is planned out. And executed by your team and by the team of, of, of. Portfolio managers behind the team, uh, you know, the different layers that we’ve talked about, um, you have all, you know, all these things are happening very dynamically.

[00:33:40] You don’t have to, like an advisor doesn’t have to figure out, should I overweight the U S or underweight the U S should I overweight Canada or underweight Canada? Should I, should I cut my holdings in bank stocks or increase them? Or, you know, should I, should I increase my duration in my bond? Uh, my bond ladder, should I, you know, these are all, [00:34:00] um.

[00:34:02] It’s all theoretically something you can think about and process in your own mind as an advisor or as an investor. That’s, that’s, that’s, that’s, that’s just one thing, but the other part is execution. Right. The execution is the part that’s, that’s the, that’s the hard part, the really incredibly difficult part.

[00:34:21] Like investing is simple, but not easy. No, no. Right. And, and, right. It’s, it’s, you know, uh, what’s the Einstein, the Einstein quote is, is, you know, try to make things as simple as possible, but not, but not too simple. Right. Right.

[00:34:35] Ilan Kolet: Exactly. So, yeah, you know, uh, Pierre. I mean, again, this is another really critical point, right?

[00:34:41] So I sometimes think about the portfolios that we’re managing, I often say are simple and elegant solutions to really complex problems, right? So diversified across managers, across the globe, across styles, across sectors, rebalancing, uh, [00:35:00] again, there’s, there’s a lot of ways to win here, right? So you. You assemble the great team who are all motivated against their own individual benchmarks, and then we do the asset allocation, right, which, which areas of the world and asset classes are going to outperform on a relative basis, and we do the rebalancing, um, and so, you know, the, these two ingredients to success, they don’t work necessarily perfectly every day or month or sometimes even every year, but the long term track record Of what of the process that we followed in our multi asset class funds has a has a proven sort of track record of success.

[00:35:41] So, you know, in terms of peers beaten and in terms of of returns, and it’s not just the 3 month or the 1 year. 10, uh, and that wedge between just a blindly passive 60, 40, which most can for most Canadians is probably too heavy in Canada [00:36:00] is giant is huge. It’s like 30 percent right over 10 years. And so again, there’s a reason why these are easy conversations for me because or enjoyable conversation.

[00:36:10] They shouldn’t say easy because, uh, I personally have a high conviction view in our process and what we’re doing. I’m personally, obviously, um, linked to the performance of the funds, but I’m also invested in them, right? Um, and I sometimes joke, like, I get, I’m, I get, you know, thousands of difficult questions from advisors from across the country.

[00:36:30] All the time through their, through their sales folks. And, but one of the hardest conversations I had to have was when my father in law, my 81 year old father in law sold his principal residence of 40 years and needed some advice on what to do with the proceeds of that home. Right. So, I mean, the, the conversation I’m having around our portfolios related to that, that father in law nest egg is, uh, is, is really the, uh, the putting the feet to the fire.

[00:36:58] Pierre Daillie: Execution, [00:37:00] getting, getting, you know, making sure like when you have, you know, when you have as many, like one person or one team, like one advisor team or one person, I think is, is hopeful that they can make all those decisions. Um, but there’s a real risk of being under informed at any given moment, um, not having all the resources that are required to make that, to make those choices.

[00:37:32] But lastly is still that, that, that big nut to crack, which is execution, like when, how to make, you know, how to make a portfolio happen, um, you know, when you can, when you can actually, uh, rely on, on, on, you know, an entire organization to. You know, carry out those instructions and those execute, you know, execute those trades.

[00:37:55] Um, you know, to me, it solves, it solves a huge [00:38:00] problem looking

[00:38:01] Ilan Kolet: at that. And Pierre, um, so this is the benefit of scale, right? So we manage 80 billion, roughly 80 billion in assets for. Uh, Canadian investors in our multi asset class funds, we report into an organization headquartered in Boston, um, where we’re, where we go, we’re there quite regularly.

[00:38:20] I used to live there, work there that manages 900 billion for global investors. 700 of that 900 billion are the U. S. freedom funds, right? These are the flagship fidelity freedom funds for American retirees. Um, You know, I can’t remember. I think it’s one in five, one in six Americans in some way touches these funds.

[00:38:44] Um, but the, the reason I mentioned that is not to impress people with 900 billion, although it is the reason that’s an important fact is we use the same infrastructure, the same portfolio analysts, the same risk metrics, the same [00:39:00] quantitative support, dedicated asset allocation research team. We’re using the same resources that, that.

[00:39:05] 700 billion sort of behemoth is using as well. And, and those are the benefits of scale, right? So like when I get asked questions, like, when are you forced to rebalance your funds? The answer is whenever we want, right? Are you, when are you forced to, if you want to be overweight, the U S when can you do that?

[00:39:22] The answer is whenever we want. Uh, if you don’t have access to a capability and you want to add it, when can you add it? And guess what the answer is when we want, right? So if there’s a capability that’s being built or developed in the U. S., uh, we’re in those conversations, right? And so this happened, I think, seven, eight years ago with the inclusion of, you know, uh, sort of probably the most well known, one of the most well known, uh, U.

[00:39:50] S. equity managers, Will Danoff, when we added him to our strategies, uh, right, we added him because He was a building block that we wanted to, um, [00:40:00] to use as an advantage in our, in our funds, you know, it’s, it’s the same sort of thing with, with new asset classes, new managers, new capabilities, new risk models, right?

[00:40:10] Those are, we’re in the conversations, uh, at the table in terms of the development and implementation. And that’s an edge to be quite frank, that’s an edge. We have a really nice chart that I’ll share with you. Yeah. After this, after our discussion showing, it’s really neat. It’s a, it’s a time series chart over 10 years.

[00:40:30] It shows the Canadian TSX. It then shows the Canadian sleeve of our Global Balance Fund in another line, which has handedly outperformed The TSX as we would hope, but then what it shows it, we have a whole bunch of gray lines. It’s kind of a spider chart showing the underlying managers that we’re using in our Canadian sleeve.

[00:40:54] Right. And the advantages. So, okay. Not only are we beating the Canadian TSX, I [00:41:00] mean, that we better be doing, uh, but the second thing, you know, the second, the second thing to note is. The volatility that exists in underlying Canadian equity managers is being smoothed by combining them, right? So, you know, we’re smoothing the Hugo’s and the Dan’s and the Dawn’s and the Mark’s.

[00:41:19] They’re getting smoothed out by us owning basically all of them in various sizes. And each size is calibrated and done in a very deliberate way. Again, um, this is the benefit of one of these research based multi asset class solutions is, you know, we can have a conversation that spans everything from like, uh, supply chain issues and supply disruptions all the way to Canada, all the way to how we’re thinking about an AI dividend and all of these ideas, right, from Every every topic under the sun are sort of implemented and being thought about in our portfolios by the [00:42:00] managers by us and by all of the hundreds of analysts spread across the globe that Fidelity has.

[00:42:05] So again, there’s no substitute for strong research. I’ll I’m a long standing research nerd. Uh, and. And there’s no substitute for high quality research and research does underpin every single thing we do in the fund from the inclusion of the manager or the asset class, the construction of the underlying fund, the long term things we’re thinking about, and then the tactical overweights and underweights, which are which is mostly the subject of this of this paper.

[00:42:32] The last thing I wanted to mention is, you know, I get I get all sorts of questions. The last question in this paper is. Will the U. S. dollar lose its reserve currency status? So originally that wasn’t going to be in the paper, but I, I really wanted it included because this is a great example, Pierre, of a notion or a subject that gets broadcast, you know, in popular media or in news or in blogs or on Twitter or whatever they call Twitter now.

[00:42:59] And, [00:43:00] uh, and when you actually look at the chart and look at the data and examine it critically. It’s way overblown, right? And so, I mean, the U. S. still accounts for a giant share of foreign exchange reserves. We have a great chart in the paper and this idea that, you know, uh, the U. S. dollar is about to lose its reserve currency status and investors get worried that, that then they, they then call their advisor and then the advisor reaches out, uh, and, and to us.

[00:43:28] I mean, this is a great example of this disconnect between sort of reality and, um, sometimes what, what, uh, what takes over.

[00:43:37] Pierre Daillie: So I, uh, before we wrap, let me, let me just, uh, let, let, let’s end off our discussion on, you know, again, it’s just, I want to stress that you’re not, you’re not. Not investing in Canada, first of all, given the outlook, um, obviously, you know, Canadian investors, advisors, uh, I think, I think we should definitely cover what your thoughts are on [00:44:00] when the Bank of Canada will, will cut rates.

[00:44:04] Ilan Kolet: Yeah. So how are we thinking about, you know, the bank cutting, um, for this, to answer this question, we really have to come back to inflation again, right? So, uh, we had an inflation print in Canada a couple of days ago. Um, it showed that total and core inflation in Canada. Uh, remains in the threes, right? So there has been improvement on the rate of inflation in Canada, but I’ll say it’s, it has admittedly been less convincing than the downward trend in the U.

[00:44:33] S. Uh, and so while the downward trend in the U. S. on core inflation has been meaningful, we have a really nice chart in our paper on this. That leads to the idea that the Fed doesn’t need to be as restrictive as they are. In Canada, it’s a little bit less of a slam dunk, right? So in Canada. The progress on inflation for a number of reasons has been a little crunchier, a little bit stickier.

[00:44:56] Um, but there has been progress and, you know, the bank does not need to be [00:45:00] as restrictive as it has been, uh, through the period of tightening and, and for most of last year. I think we’re going to probably see the bank move, change its stance, and this will first come through in the language, and we’ll talk about that, you know, towards the middle of this year, into the end of this year.

[00:45:18] Um, again, we don’t forecast individual meetings, uh, because we don’t, we don’t really think that that’s very helpful, but. The way that we are thinking about, about monetary policy, both in the U. S. and in Canada is by the end of this year, it won’t look as restrictive as it has been a couple of clarifying points, Pierre, first, a move from five to four, let’s say we’re at five and we move to four, that’s moving from very restrictive to restrictive.

[00:45:45] Right? Right. But the bank is, and that’s not stimulating, right? Uh, the bank, uh, that’s just less restrictive. The bank is well aware of the excesses in the housing market, the stretched level of household balance sheets, [00:46:00] um, and the fact that in 2023, the Canadian economy did not grow at all, right? So Canadian GDP was a flat line and in per capita terms, given the surge to, surge in population and immigration, In per capita terms, growth has fallen, right?

[00:46:14] GDP growth has fallen per capita. So, it’s not a great picture already in, in Canada. And so, the bank needs to be very, very careful about not sort of imploding the Canadian household, uh, the Canadian housing market and, and Canadian businesses and Canadian capital spending. That said, they still need to see, um, sustained and consistent improvement on, on underlying inflation because that’s their only job.

[00:46:42] That’s the only job. Right. And we’ve seen quite a bit of that, but we still need, we need to see some more of that. And then the last point is they will take us on a leash on to BOC day to Fed day on what they want us to think, right? 25 cut, no change. And they will do that [00:47:00] in speeches and communi, and, and, and communications and monetary policy reports that come between interest rate decisions, right?

[00:47:07] So what we will see. Is we will see the language of all right. Just like we saw Powell’s language of all at the end of last year, we’ll see Governor Macklin and the deputy governors come out in speeches across the country and in media interviews and slowly start to sort of guide and change the expectations that we’re seeing.

[00:47:29] We haven’t seen that much of it. In Canada, uh, we’ve seen a, we’ve seen a measurable change in the U. S., but I expect in the next couple of months, we’ll start to see this, um,

[00:47:38] Pierre Daillie: in Canada. I think it’s probably something that, that most Canadians are, are, uh, you know, holding out hope for will happen sooner rather than later.

[00:47:48] Where’s inflation heading? I think, I think there’s been some talk of inflation volatility and what are your thoughts on that? I think, and some of that may be addressed by the fact that the Fed is only [00:48:00] telegraphing three cuts versus the markets jumped to six. Um, so. Would you, is it somehow factored in the, in the differences, uh, the, the concern that, that cutting rates could cause a resurgence in some quadrants of the economy, inflationary surge, uh, like inflation, volatility, and, and, you know, like when you cut rates and then inflation comes back and then you have to hold off on the next cut, or you might have to rise, you know, raise again.

[00:48:31] Yeah, I would say. What are the odds of that?

[00:48:33] Ilan Kolet: So, I think they’re low, but not impossible. Right? So, what do we know? We know that through the pandemic, I mean, this is all stuff we know, in the pandemic, we were locked into our houses, we could only buy goods prices, goods prices, and there were fewer of them, fewer of those goods because of the supply chain shock, goods prices went straight up and really boosted inflation.

[00:48:53] The goods price shock today is gone, right? So goods are now inflating at pre COVID rates, cross goods [00:49:00] off the list as an upward contributor. And again, we have a very nice chart in this paper showing the Contributors from goods and services, but we’re left with our service prices. So services, uh, the, the price of a service is determined by the price that you pay the person doing the service, right?

[00:49:16] So contracting electrical services, guess what? That’s the price of that contractor. And that electrician, and they’re a lot more expensive because, um, unemployment rates are low. Right. And, and, and there’s just a scarcity and, and more demand and, and that’s pushed up wage growth, which has pushed up service prices.

[00:49:34] What we have seen, especially in the U. S. is service prices have slowed, right? They’re not deflating, but they’re, um, they’re not going up as quickly, but they’re not going up as quickly. Right. And service prices have slowed. And that’s why the 6 month annualized rate of core PCE is 1. 9%. Uh, to your question, Pierre, this idea that if we get, um, if we get declines in rates in monetary [00:50:00] policy, does this lead to a resurgence in inflation?

[00:50:04] There’s been a lot of lessons learned from global monetary policy and, uh, and central bank, central bankers from that episode in the 80s when exactly that happened, right? So. When the Fed was too quick to cut, and then there was that, that hook higher. This is why you’re going to see the move, you know, it’ll be quite glacial.

[00:50:23] It’ll change, first the language will change, then they’ll take us on the leash to the Fed day, right? And it will be, it will be quite glacial. That said, they don’t want to be too restrictive for too long. Again, if you’re moving from five, call it five to four, you’re still restrictive, you’re just less restrictive.

[00:50:40] And you have to recognize the improvement in inflation, the drip tire and the unemployment rate. Drift higher and the unemployment rate should correspond to less demand, less wage growth, less service prices. Right? So I would say it’s not impossible to see some of the categories tick higher, but in general inflation, especially in the U.

[00:50:58] S. is convincingly [00:51:00] heading in the right direction and rates just don’t need to be as restrictive as they’ve been.

[00:51:04] Pierre Daillie: Amazing. It’s been great having you. Uh, I’ve really enjoyed our conversation today. Um, Thank you very much for, uh, for agreeing to come back and, uh, to cover your most recent white paper, which everybody should read.

[00:51:19] Um, it’ll be in the, uh, show notes below. And, um, Ilan, if, if, uh, if advisors want to find you, what’s the, what’s the best place to find you?

[00:51:30] Ilan Kolet: We have a incredibly talented and gifted set of, um, a, a, a sales team, right? Fidelity Wholesalers. Anyone listening, uh, will, will have someone that they can access on the sales side, right, that can link them into the papers, the podcasts that I do, the webcasts that I do, um, you know, I, I speak from coast to coast, uh, and I, I, I love that.

[00:51:53] You know, so I’m, I’m certainly available. The best point of contact again, is that, is that Fidelity salesperson that, [00:52:00] um, all the advisors on this call should, should know. And if they don’t, they should get to know.

[00:52:06] Pierre Daillie: Awesome. Ilan, thank you so much for your incredibly valuable time and your insights today. Um, it’s been great having you.

[00:52:13] I hope to, uh, have you again very soon. Thanks

[00:52:16] Ilan Kolet: Pierre. Yeah. Happy to do this anytime you’d like.

Listen on The Move


 

Ilan Kolet, Institutional Portfolio manager in Fidelity's Global Asset Allocation Team, joins us to discuss the most important questions he and his team mates, David Wolf and David Tulk have been fielding at the start of 2024. We delve into the unexpected shifts in monetary policy led by the Federal Reserve and mull over the repercussions of potential rate cuts on inflation volatility, weaving through the intricacies of the Fed's data-driven stance and 'pivot' toward a less restrictive monetary environment.

In the context of historical reflections and economic projections, Kolet elaborates on the team’s optimism regarding the US market, supported by a belief in a productivity boom that dallies with the possibility of economic prosperity, low inflation, and equity strength. We get into Canadian fiscal policy, where Kolet voices concerns about Canada's macroeconomy potentially trailing in equities and fixed income, and how the team is allocating to Canada. Kolet sheds light on the team’s investment strategy, from high-conviction underweights and overweights to the complexities and nuances of handling asset allocation.

Throughout the episode, it's clear that the core of the discussion isn't merely the transactional aspects of investment but relates to the broader challenges advisors face when reconciling market complexities with client needs. The episode provides Fidelity's highest conviction global asset allocation guidance through the labyrinth of 2024's financial mixed and uncertain landscape.

You may view and download the 11 Questions for 2024 whitepaper below:

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