- Investors need to reset their expectations for what a balanced portfolio should yield, according to Lori Heinel, the deputy chief investment officer at State Street Global Advisors.
- The world's third-largest asset manager is of the view that marketwide returns will be anchored in risk-free interest rates - and argues that rates could remain structurally lower for years to come.
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It is high time that investors reset their expectations for what market returns should look like, according to State Street Global Advisors.
This clarion call from the world's third-largest asset manager is rooted in the firm's projection for interest rates.
Bond-market investors have plummeted the yields on short-term interest rates recently amid demand for a safe haven from geopolitical turmoil.
Beyond this rationale, State Street is of the view that interest rates have approached historic lows because markets are adjusting to the reality that economic growth is likely to be structurally lower even if a recession is proverbially kicked down the road. And by extension, borrowing costs could fall even lower whenever the feared recession materializes.
A world of lower interest rates has far-reaching implications for asset classes from fixed income, as expected, to stocks, whose valuations are adjusted for the prevailing discount rate.
A low-rate environment also implies that balanced portfolios containing stocks and fixed income are unlikely to yield the high-single-digit returns that prevailed in the past, according to Lori Heinel, the deputy chief investment officer of State Street, which has nearly $2.9 trillion in assets.
"Even when you add active management and illiquid assets, it's just not going to happen because ultimately, everything starts from the building block of interest-free rates," she told Business Insider in a recent interview.
What State Street is buying now
The question for money managers, she said, is about how to get clients adapted to a new world where returns are likely to be lower.
The answer involves finding the highest-quality assets that provide decent returns, even if a balanced portfolio eventually yields less than what investors are accustomed to. Heinel shared with Business Insider four areas of the market where State Street is currently fulfilling that quest:
- State Street has been building a position in real estate investment trusts even though their yields have been hurt by the recent plunge in interest rates. But besides rates, Heinel said investors can also win in this asset class if the economy continues to expand and benefit properties like warehouses, Class A office space, and multifamily housing.
- State Street added a new position in gold exchange-traded funds this year, Heinel said. It's a bet that has paid off so far, thanks to demand for safe-haven assets. Gold serves both as a hedge against extreme market outcomes and as an investment that has little to no cost to carry, she said.
- Heinel further recommended gold-mining stocks as a relative-value play on the shiny metal because some companies have not rallied as much as the commodity itself. The VanEck Vectors Gold Miners exchange-traded fund is the largest for companies in this field.
- Heinel is also eyeing high-yield bonds, with a 2% overweight. She noted that the market has been bumpy with a few rolling recessions, ranging from the energy crisis some years ago to the pain in apparel retail. But there is opportunity on the other side of this coin, which can be found in higher-quality companies. That practically means sticking with BB-rated firms at the highest rung of the non-investment-grade scale.
- In terms of areas that State Street is cautious about, Heinel specified high-growth technology stocks because their valuations may be unsustainable, as well as utilities, because they recently had a good run as bond proxies.