David Lebovitz: Welcome to the Center for Investment Excellence, a production of JPMorgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment themes.

Today's episode is on asset allocation in 2022. It has been recorded for institutional and professional investors. I'm David Lebovitz, Global Market Strategist, and host of the Center for Investment Excellence. With me today is Jared Gross, Head of Institutional Portfolio Strategy for JPMorgan Asset Management.

Jared Gross: David, thank you. Thank you for having me. We're really happy today to be presenting something a little different for the listeners enjoyment. In the spirit of year-end, David and I thought it would be interesting to talk about asset allocation in a slightly different way, which is, we are going to conduct an asset allocation draft, going through a variety of asset classes, and taking those that we think have the best prospects.

Before we get there, we're going to begin with a little bit of a macro update, talking about the kind of environment we're facing to sort of set the backdrop against which we're going to be looking at these various asset classes. I'm going to then come back in. We'll talk a little bit about sets of priorities, about what we need from an asset allocation in this environment, what we're hoping to achieve, what our strategic goals are.

And then we're going to draft. We're going to go through four rounds, with a wild card round at the end. We're going to focus each round on a particular market sector, and then we'll spend some time discussing the various considerations around investment opportunities in each of those sectors, before one of us steps up to the mic to make the selection.

So, with that, I'm going to give it back to David for the macro backdrop. David, back to you.

David Lebovitz: All right, great. Thanks, Jared, and hello, everybody. Thank you for joining us for this exercise. So, it's interesting. The past couple of days here has seen a lot of the thesis for 2022 really called into question as the Omicron variant has taken control of the headlines, and taken control of market performance as well.

The big question that we've been getting asked is, how much of a risk does this represent? And right now, the short answer is, we just don't know. I think it's a bit of a stretch to think that we head back to lockdowns like we saw in March and April of 2020. But if this thing does prove to be more contagious than some of the other variants, even if it's less lethal, it could have an impact on the mix of consumption.

It could have a modest impact on the overall pace of economic growth, but we think that this is very much a pause or would be a pause, rather than the beginning of a broader pullback. And the reason why is that we see three fundamental drivers that are pretty firmly in place that we believe will allow economic activity to remain above-trend throughout 2022.

And these are things like the financial position of the consumer. The consumer looks excellent. So, we think that consumption can very much be a tailwind for the global economy next year. I'm sure everybody who's listening in, has recently ordered something and been disappointed in the amount of time it took to arrive.

Not only are there challenges when it comes to getting things from A to B, but now there's not a lot of stuff sitting at Point A. And so, we do think that the inventory rebuild that really began around the end of the third quarter, should continue into the end of this year and the beginning of next year, providing support for the overall pace of economic growth.

And then the final thing we're looking for here is more on the investment spending side, the CapEx side of the equation. Historically, there has been a tight relationship between profit growth and then capital spending 12 months later. We've just come through a period of spectacular profit growth.

You're hearing from corporations, they recognize some of the risks that are stemming from higher wages and higher input costs, et cetera. And so, we do think that investment spending is going to pick up here, and that is going to be kind of the third leg of the stool when it comes to economic growth in 2022.

Fiscal stimulus is fading. We do still think that both infrastructure bills will be signed into law before the end of this year, but we're not really worried about significant fiscal cliffs in 2022. And that really has to do with the underlying nature of the stimulus that we've seen. It wasn't government spending in the traditional sense. It was more a redistribution of liquidity.

And so, that's what I was saying about the consumer, right? The consumer is sitting on an elevated cash balance. The consumer is ready to consume. And I think that while we expect the pace of growth to slow next year, again, it should remain above-trend and we don't foresee some big fiscal cliff that the economy is going to go shooting off of at some point during 2022.

The big risk from where we sit is really on inflation. Powell came out and said it earlier this week. Inflation is no longer transitory, and also tipped the cap to the idea that tapering may be accelerated when the Fed gets together in the middle of December. To me, tapering remains distinct from tightening.

I think that the reason they want to accelerate the taper, is that they're worried that capital markets are starting to run a little bit too hot here. But I think at the end of the day, the hurdle for raising rates is a bit higher than what the market currently believes it to be.

And while we do think that the Fed will hike rates at some point here, by our lights, it's more of a late 2022, early 2023 phenomenon, as opposed to, again, what's being priced into futures markets here in the current environment.

And so, the Fed is going to move a little bit more slowly on the rate front than a lot of people currently think. The tapering very well could be accelerated here in the coming weeks. And generally, this leaves us with a fairly constructive view for the global economy next year, one characterized by increasingly synchronized and above-trend global growth, inflation, which remains elevated but comes off the boil, and fiscal and monetary policy, which don't necessarily materialize into headwinds, they may not be the tailwinds that they've seen over the past 18 months, but we don't necessarily think that they will end up derailing the broader expansion.

And so, with that kind of as the background, Jared, maybe I'll pass it back over to you and we’d love to get an understanding for the type of player we're looking for here as we embark on our 2022 draft.

Jared Gross: Yes. Thanks, David. That’s a great macro overview, and I think it's a good segue way to the type of attributes that stretch across asset classes that we want our portfolio, both in its entirety to embody, but also in each individual component. What are the types of characteristics that we think are going to be most impactful in generating positive performance, hopefully, with low to moderate risk in the years beyond?

So, the first theme is cash flows from our investments that are ultimately linked to nominal GDP. This is an inflationary environment. Fixed long-term cash flows are going to have less value than those that can adjust higher over time. And that's an attribute that is not limited to any particular asset class. It can come from a variety of asset classes.

We see that in certain characteristics of equities, certain types of fixed income, certainly real assets and alternatives, can embody that type of cash flow structure. So, that's maybe the first piece of it. And I think we also want to be mindful that for assets that explicitly price in inflation expectations, which are certainly very high right now, have we already sort of missed that train, and what's going to be left in the trade going forward? So, we want to hopefully identify assets that still have the capacity to grow revenue, to grow income, to grow their cash flows, and haven't already seen the best moments of this inflation cycle.

The second attribute is low duration. And you can think about this both empirically in the fixed income sense, which is a quantitative measure of the sensitivity to movements and interest rates. And certainly, we expect interest rates to be moving higher, not lower. And so, duration is going to be a headwind to returns, not a tailwind.

But you can also think about it in a broader sense, that asset classes that are sensitive to low discount rates, certain types of equity may be particularly sensitive. Certain types of alternative asset classes that rely on leverage or longer-term cash flows and exits at higher multiples, things like that, which may have an embedded sensitivity to higher interest rates, we have to be a little careful about that. So, all in all, we would preference higher near-term cash flows to more return in the out years, if you want to think about it in those terms.

I think concurrent with that is income generation. And specifically given that public markets, particularly traditional fixed income sectors, offer a very low level of income today. And that's true whether you're talking about government bonds or most sectors of the credit market.

We should be willing to trade away some liquidity to increase the income in our portfolios. Income obviously has its own benefits for most investors, particularly if you're an institution that pays regular benefits, or has to provide support to your parent, income has real value.

But even in a more abstract, long-term sense, it tends to reduce that duration sensitivity, and makes you more resilient and better able to then pivot once rates have moved higher. And I think that degree of flexibility is something that we’ll come back to later.

Fourth category or characterization would be a global focus. It is certainly the case that many global markets are more attractively valued on a multiple basis or on a yield basis, than some developed markets. And so, we want to be willing to expand the opportunity set globally.

We also recognize that, depending on the direction of currency movements, there can be a positive carry associated with moving offshore, particularly if you're a US-based investor. And so, that can be a substantial source of return and diversification to portfolios in an environment like this one.

And then finally, echoing something that David, you just mentioned a moment ago, generally speaking, if you can find a linkage to the consumer economy and consumer balance sheets, that's going to be positive. There's a lot of liquidity in consumer balance sheets.

Housing markets have done well. Stimulus has been very effective at not just bridging the gap for consumers who otherwise lost other sources of income. We've obviously seen a pent-up level of savings that should be unleashed going forward. And so, whether you're talking about consumer-focused equities or certain securitized credit assets that are linked to consumer balance sheets, we tend to favor that type of risk right now.

So, those are sort of high-level themes that spread across various asset classes. And having lined that up against the macro backdrop, I think it's now time to pivot to the specifics of our draft, and I think we're going to go through a series of asset classes. First would be core real assets, then we're going to do financial alternatives, then equities, then fixed income, and then finally, our wild cards.

So, David, I'm going to hand it back to you to begin the discussion for core real assets.

David Lebovitz: Awesome. Thanks, Jared. And it's interesting when we think about real assets broadly and the core part of that asset class in particular, you know, I don't really believe in silver bullets when it comes to investing, but I think in the current environment, this is really as close as you're going to get.

I've said to a number of clients as of late, look, the bond market is broken, right? The bond market gives you one of two things. It either gives you diversification, or it gives you yield. And there aren't really any securities left that provide you with both.

And so, this opportunity has been created for things like core real assets, real estate infrastructure, transportation, to come in and provide, not only uncorrelated streams of income, but in certain cases, inflation protection as well.

And I think that that's where it becomes a really interesting conversation is, historically, you think about fixed income. I mean, inflation is like the worst thing in the world, unless you're sitting there holding some sort of security that indexes itself to inflation.

When it comes to income generation using core real assets, you know, inflation can actually be your friend at the end of the day, because to your point, earlier, Jared, can help enhance the cash flows that these assets are generating.

And so, to me, it's really, and I don't want to use the three-legged stool analogy again, but I think I'm going to, right, it’s about the three legs of the stool being diversification, inflation protection, and yield. And what I think is particularly interesting is that you look at real estate, and we've really seen a bifurcation in that market where multifamily housing and industrial vacancy rates have continued to (plunge to) new lows, whereas the office and the retail sectors are still struggling to come back online.

Infrastructure, you know, a case of two infrastructures, if you will, if you look at utilities or contracted assets, they very much have benefited to an extent from the environment that we've been in, whereas you think about more GDP-sensitive assets like trade terminals and ports, and they obviously have been under pressure, particularly ports and airports more specifically.

Finally, there's transportation, and I don't like to say that there are assets that have benefited from the supply chain disruptions, but the transportation sector has. Lease rates are up. Freight costs are up. It's difficult to get your hands on containers, and they've been the direct beneficiary of the stress in that space.

And so, I think whether you look at the fundamental forces at play in these asset classes, or you just think about those three pillars of diversification, inflation protection, and yield, and it's a pretty compelling space to be looking to, given that broadly speaking, we remain in, and are likely to remain in, what is a historically low interest rate environment.

And so, Jared, maybe I'll kick it back over to you to shed a little bit more light on these asset classes from a micro perspective.

Jared Gross: Yes, I will do that. And before I step to the mic with my selection, I'll maybe give a little bit of an outline to how I think about the space. What makes the broad core real asset space interesting are a couple of fundamental characteristics that you hinted at with your silver bullet analogy, which is, these are really hard to find in other places, but you have very long-term stable cash flows that you can underwrite to a high degree of confidence at the counterparty level.

You think about the leases in office buildings or warehouses or industrial properties. You think about the leases on container ships or bulk carriers that the transportation investors own. You think about the long-term power contracts that a utility pays to the generation facilities.

All of these are long term fixed cash flows. They're basically fully valued. You're not owning these assets because you expect them to appreciate in value and you can sell them at a later date at a higher price. There are certain segments of core real asset where that is the name of the game. And those really tend to be more outside the core space, but core plus into value add and opportunistic.

But when you're really talking about the core, you're talking about these fully stabilized cash flows that you can underwrite, you can measure, and you know the quality of the person paying you on the other side. And you tend to own these, and this is also important, in open end vehicles where you have the ability to deploy capital on a speedier basis, and you have the ability to get some predictability around the return of your capital, not way in the out years after a long lockup period, but after a more modest period of time.

And of course, these are not daily liquidity investments. You can't expect to have your money on a moment's notice, but you have more flexibility as an investor. And I think in an environment where we expect to see reasonable level of volatility across asset classes, both within those open-end vehicles, it provides flexibility to the investment teams to reallocate capital, but it also allows investors at the strategic level to pull capital out and put it back to work more expeditiously. And those are really valuable attributes.

With respect to the specific area that you discussed, I mean, real estate, COVID has been, to me, an object lesson in the power of diversified real estate investing, in that, yes, some sectors have obviously suffered, central business district office space, and retail malls, particularly enclosed malls, but all types of retail have suffered.

But at the same time, life science, industrial, multifamily, distribution facilities, these have all surged in value. And so, a diversified portfolio that is able, not just to own some of those sectors that are attractive, but also monetize them at attractive exit points, and reallocate that capital back into things that may be a little bit undervalued, that migration of a portfolio across time, and the ability to keep capital invested and compounding across time, is enormously valuable. And we should not lose sight of that just because a particular strategy happens to own a few office buildings or a few malls.

Infrastructure, I think you hinted at this, but there is a very powerful secular trend in favor of infrastructure investment. This is an area that has been underinvested in for decades now. There are certain types of infrastructure that are always going to be the responsibility of the public sector. We don't anticipate local roads becoming privatized and turning into investment opportunities.

But in the core space, what do we tend to see? We tend to see power distribution, generation. We tend to see more sort of GDP sensitive assets that have a linkage to energy distribution and goods distribution. Think of rail cars, railroads, pipelines, barges, things like that.

And there's a lot of really new areas that are emerging, and this is where you start to see a blend between infrastructure and transport, ships that service wind farms, offshore, specialized technology that's coming online. These are enormous opportunities. And with transport particularly, I think this is an area that is just underinvested.

It's a business that for much of history was the province of the banks, and they lend directly against these assets, and they were owner-operator businesses. That has now shifted to the point where the ownership of the vessels is now in the private investors’ hands, and the major carriers are leasing these vessels, and that's a huge opportunity.

So, with that as the backdrop, I guess it's time to make the first draft pick in the core real assets space. Your very first comment of the call about how everything's a little bit up in the air because of the Omicron and the potential resumption of COVID. If you had asked me this two weeks ago, I probably would have stepped to the mic and said I was going to pick transportation, because I think the level of return that's available there, is really compelling.

And I still have a lot of faith in that sector, but I do think I'm probably inclined to pivot now back to infrastructure, just given the enormous kind of policy tailwinds you see coming out of the infrastructure bill in Washington, coming out of the European government support for diversification of the energy sector. So, the first pick in this year's draft in the core real asset category is going to be infrastructure.

David Lebovitz: Awesome. So, I want to change gears here a little bit and move on to talk about financial alternatives. And what I would say about financial alts is, this is a space that continues to grow. There are a lot of really, really talented players, and there are differences between the various types of assets.

Private equity is very different from private credit. And within private credit, you have things like mezzanine loans, distressed investors, direct lending, so on and so forth. So, it's a very broad asset class. But in general, this increasing diversification is attractive from where we sit because we think, depending on where you look, you can find assets that will allow you to achieve the outcome that you're pursuing, or help you solve the problem that you're looking to address.

A couple of high-level thoughts here. You know, before the pandemic, we weren't terribly comfortable taking risk in direct lending. We thought that it was very much a borrower’s market, a lot of cov-lite issuance, a lot of EBITDA adjustments. That effectively has changed. The cov-lite phenomenon has really evolved into a public sector phenomenon, whereas the private side, particularly in the middle market space, we're seeing fairly high-quality loans be made.

I do think distressed investors will have an opportunity at some point, not necessarily tomorrow, but maybe 18 to 24 months down the road, as policy continues to be walked back from its very accommodative stance. And in the interim, to your point earlier about real estate, Jared, when we look at senior commercial mortgage loans, when we look at mezz debt, both of those look pretty intriguing given the risk adjusted return that they can provide.

And so, lots of interesting things on the private credit side. On the private equity side, again, important to differentiate between the major types of strategies. You have everything from venture to traditional buyout, growth equity kind of providing the bridge between the two. And to me, what it all comes down to, is that the public opportunity set is getting smaller in terms of the number of companies.

The size of these public market opportunities, however, is getting larger. And importantly, the underlying exposure that the public markets now provide, is very different from what you can get on the private side of the equation. And as we've seen, private markets are much more oriented towards things like technology and growth, than is the case on the public side of the equation.

And so, for investors who are looking for ways to enhance the overall rate of return in their portfolio, we think that there are a variety of different levers that can be pulled within the private equity space more broadly. Before I make my pick on this one, Jared, maybe I'll pass it back over to you. Would love any additional thoughts that you have on the financial alternative space broadly.

Jared Gross: Thanks, David. I agree with you. I think this is an area that is growing and has begun to supplant the public markets in a variety of areas. And it's not lost on anyone that companies are able to reach much higher levels of capitalization and scale and operating leverage and profitability completely in the private space, you know, pre-IPO, which didn't use to be the case.

To the point where this type of private assets, which used to be something of a niche in portfolios, is really now almost a parallel universe. And we have to think about it as private credit and private debt alongside public markets and private equity and venture and growth equity alongside public equity and buyout and stress as a way to take advantage of different parts of the lifecycle of an enterprise in ways that maybe we didn't have access to previously.

And as that continuum fills out, entry and exit from each of those individual components, should probably become a little bit easier. You're going to see more deals between private investors, as opposed to between private and public markets. And that may also lead to fewer grand slams, where you buy in early and take it public and go 100x or whatever the top of the line is for that type of payoff, but also fewer strikeouts.

There's just more people waiting to take on risk at different parts of the capital structure, different parts of the life cycle, different opportunity sets, different return targets, different liquidity vehicles. It's just a much richer opportunity set. And so, I guess the big point I would make around these types of alternatives is, they should become a larger part of your portfolio.

They simply need to be a bigger footprint in an asset allocation than they have historically been. The only caution to that is the nature of risk management has to shift a little bit. We have historically viewed risk management as being primarily around building a pool of uncorrelated or low correlated asset classes.

And because alternatives were off to the side and they were relatively modest in size, we could look past the fact that they were both difficult to model and idiosyncratic, and potentially correlated to other things, but also the volatility was suppressed by virtue of slow mark-to-market of the underlying investments.

I think what has to happen in concert with larger alternative allocations is, we have to become more sophisticated around managing liquidity. And so, that becomes a bigger and bigger piece of where we have to focus. And so, all of these assets fit into the model. It's really a question of investors developing the skills and deploying those skills to manage a larger pool. So, I'll hand it back to you for pick number two.

David Lebovitz: All right. Thanks, Jared, and this is a close again. I kind of feel like I'm picking amongst my children here. But I think given what's gone on in public equity markets over the course of the past 18 months, private equity is going to be my choice here because I think that being able to get your hands dirty and really drive operational improvement, is going to be a key differentiator when it comes to generating returns here going forward. So, private equity it is on this one.

Jared Gross: Now, David, let me press you on that for a second. Do you have a view on large cap buyout versus mid-cap smaller deals in that space? Where do you see value in private equity?

David Lebovitz: So, I would be inclined to orient more towards traditional buyout. And the reason why is that, one, I think you can pick up that growth exposure that I talked about just a few minutes back, but at the same time, you haven't really seen traditional buyout investors begin to pick through the rubble of COVID.

Deal activity in say restaurants and leisure and hospitality has been somewhat muted. And so, I do think that as we continue to move past the pandemic, that's going to be a really interesting way to generate capital appreciation in portfolios in a way that maybe in venture, you're going to be more oriented towards tech and growth, and you're not going to be able to pick up that “beta” that you can in the larger buyout space.

But I actually think that's a perfect segue way, and I know we're running a little bit long here, so we'll have to move quickly. The public equities. So, what do you do when the stock market's up 100% from its March 2020 low? How do you think about allocating to public equities, particularly against the backdrop of elevated valuations?

And what I would say is that first off, it's important to recognize that while stocks do look expensive relative to their own history, they continue to look cheap relative to box. And so, from a portfolio construction context, we're still very comfortable leaning into equities, but we're becoming much more nuanced in our underlying views.

And to me, the key to success next year is really going to be to follow the earnings, right, owning those sectors and those geographies that have earnings streams that are most sensitive to the underlying pace of economic growth. And so, in the United States, that means not growth or value, but really a blend of growth and value.

One of the things we show in our Guide to The Markets is that sectors like industrials, financials, but also technology and communication services, have historically exhibited earnings streams that are most sensitive to the changes in real GDP.

And then if you take that same thesis and apply it globally, where you find yourself is leaning into those more cyclical markets, places like Europe, and even Japan, in certain cases, where you do have that higher beta, that greater cyclicality.

And I think that those are the areas that look most interesting to us as we think about kind of allocate public equity portfolios here over the course of the next couple of years. But Jared, maybe I'll pull you back into the conversation. Anything you would want to add on the public equity front?

Jared Gross: I don't have too much to add here. I think you've got a very good grasp of where the equity market stands today. I think in keeping with the earlier comments on the growth of private markets, we do see the public markets evolve in terms of their role in investor portfolios.

If you're going to be capturing a greater amount of the growth upside in private strategies, you have to think a little bit about what the purpose of the public equity markets are to you as an investor. And I think to some extent, public equity managers and executives, are kind of recognizing this because we have seen a resumption of the focus on dividends, on buybacks, and the return of capital.

And it may be that going forward, and this is sort of a long-term thesis, but the equity markets are going to be as much about how to efficiently get capital back to your investors, as they are about raising the capital needed to finance your growth and investment in CapEx and so forth over time.

And I think that's an interesting evolution that seems to be taking place. Now, that's not to say you can't get growth out of public market equities. You certainly can. And I will say as my final comment, this is very much the time for active management, where the degree to which most cap-weighted market indices have become increasingly concentrated in large cap growth names, and are less diverse both by sector and name than they have been at most points in the past, suggest that there's a lot of overlooked opportunities out there.

And I think that is the way to be investing in equities, whichever sector you tend to focus on. So, I'll hand it back to you for the selection.

David Lebovitz: Yes, totally agree. Valuation dispersion is another important issue. You know, it's still sitting wider in the S&P than it was during the tech bubble, which again, lends itself quite nicely to active management. So, I think where I’d shake out on this one is, I'm going to choose US equities as my choice.

And not trying to undercut my comments about the cyclicality that's present in markets outside of the United States, but I do think that US equities give you a little bit better balance in terms of allocating between growth and value, quality and data, so on and so forth.

And again, when we look at the S&P and the sensitivity of different sectors earnings to real growth, you can really compile a nice portfolio, a nice balanced portfolio of equities. Whereas if you were to hang your hat on an individual country or region, you'd arguably be taking a lot of exposure on in one specific industry or sector. Longer term, maybe I'd go into EM, is my time horizon for the next 10 years, but given the nature of this exercise, US equities is the choice for me.

So, that brings us to round four, fixed income. Maybe just a few quick thoughts around Fed policy and the passive rates. I kind of unpacked this earlier on in the conversation, but to me, a couple of things to remember and keep in mind. Tapering is not tightening. They're going to accelerate the taper. They seemingly are going to accelerate the taper because they're worried about financial markets overheating.

We're still in a world where rates are going to be lower for longer. I mean, one of the things that I'm constantly reminding clients is that from a structural perspective, the economy hasn't really changed because of the pandemic, right? At some point here, we're going to be back in the world of twos, 2% growth, 2% inflation, and very low rates. And so, while long rates may rise over the coming year, again, I don't think that they're headed to the moon, unless inflation really ends up getting out of hand.

And then finally, on the curve. We think that the curve will steepen as global growth accelerates. The flatness we're seeing today, suggests that markets are a little bit concerned about a policy error. They also recognize that longer term, we're kind of going to be back in the same world that we were in post GFC.

And so, the fixed income conundrum, as we've begun to call it, really hasn't gone away. And Jared, would love your thoughts on any places where you might be able to generate some real rate of return.

Jared Gross: Well, I hate to disappoint you, but finding real rates of return in fixed income is not very easy these days. And I liked your characterization of the fixed income conundrum. It is a challenging place to articulate a positive case for where you want to take risk right now.

I think in my earlier comments, I highlighted some of the attributes we're looking for from investments broadly, and many of those apply to fixed income, even though they are fairly hard to find. And for sure, duration is not going to be your friend in the years to come. Now.  I think what's interesting in that conversation is, we expect rates to rise. The question is, we don't know exactly when. If you expect a more front-loaded pace of Fed normalization, and I'll come back to this with my pick in a moment, then you want to be defensively positioned and kind of wait for that and take advantage of it when it occurs.

If you think the Fed is going to be lower for longer, and then that pushes you out to maybe some of the more frontier fixed-income assets, a little more illiquid space, a little more in the credit-sensitive space, maybe down the capital structure a little bit, places where you can pick up yield because the fundamental reality is, with inflation running where it is and interest rates where they are, it is virtually impossible to generate a positive real rate of return in fixed income right now.

And certainly, in the most common liquid markets. There's just nothing available that's going to generate anything other than a negative real yield. And so, we don't like duration at this moment in time. Moving out of the curve as a way to enhance yield is not particularly compelling.

Spread risk is more interesting, in part because it benefits from the type of economy and economic environment you were speaking to, but it's already incredibly rich. I mean, that trade has been priced in. There are sectors of spread that we like more, I would say, particularly securitized credit, and areas that are linked to the consumer economy, so certain types of ABS.

Multi-family agency mortgages are an interesting opportunity, but even there, the level of spread available is not compelling by any sort of historical standard. So, if your starting point is Treasury bonds, yes, you can do better than that, but from a total return perspective within a portfolio, it's not very compelling.

And I think this raises a more fundamental question about portfolio construction, which is, normally we hold bonds to be the defensive asset against equity. So, when equity sells off or some other risk assets sells off, we can sell our bonds and move into that asset to generate higher levels of long-term return.

Now we're forced into a position where we have to hold defensive bonds against our fixed income risk. And so, when interest rates rise, we have to move from one bond to another, and that maybe limits our flexibility down the line to be proactive as other markets move.

And does suggest that holding large positions in more volatile equity assets that have less tails and so forth, is riskier these days, not just because we don't know what the correlation is going to look like, but because we have to preserve that liquidity within our fixed income portfolio so that we can migrate our fixed income portfolio to more attractive positions down the line.

So, with that, I think I'm teasing what I'm going to choose, which is a very safe pick. I was going to criticize you for being a little wimpy about picking US equity, which is, you know, obviously the easiest choice of all time, but I am going to go choose short-term fixed income here.

I'm not going to be a hero in the bond market. I think the prudent path right now is actively managed short-term fixed income, the ability to move off of treasuries into credit selectively, particularly into a more diversified set of spread sectors, including securitized, is the right way to preserve capital, minimize the impact of negative real yields, and essentially live to fight another day.

And that day will come when we can pivot off of those assets and either buy more attractive fixed income or deploy that liquidity elsewhere. But this does not feel like the time to be a hero and take on a lot of excess risk in your fixed-income portfolio. So, my pick is short-term bonds.

David Lebovitz: And I totally understand why. And so, maybe just to wrap up here, we'll do a wild card lightning round. We can just throw our picks out there because I think we've made the case for a bunch of different assets, some of which we've selected, some of which we have not. And then I'll take a crack at wrapping this all up and we can call it a day.

So, for the wild card, you get to pick from anywhere. My pick here would be middle-market direct lending. I think the quality is good. I think the yield is obviously attractive. And again, income is hard to find in the current environment. So, that's my thought there. Jared, how about yourself for the wild card?

Jared Gross: So, if you had asked me this two weeks ago, I would have said tail risk hedging because I thought the VIX was looking pretty low and the markets were ripe for a sell-off. Unfortunately, by the time we recorded this call, that has come to pass. So, I can no longer choose it.

Actually, I probably am displaying a little bit of recency bias because I got a terrific presentation this morning from our team that invests in timber. And I think the story behind that asset class is so compelling right now.

Not only do you get something of an inflation hedge, but unlike TIPS where all the inflation protection is realized at maturity, a timber portfolio can be monetized when prices are high. And it's a very interesting way to play the inflation story.

And also, with ESG becoming more and more the norm, and companies looking to get to net zero, carbon offsets are going to become an enormously valuable attribute of timber portfolios. And I liken this to the Texas rancher in 1900 who thought he was living life to the fullest with cows in a field, and then he realized that he had oil underneath the ground and was a billionaire the next day.

Timber - the ability of carbon offsets to help increase the return and value of timber resources, is just really interesting. I think we only begin to see where that's going to go, and I think it's a really interesting place to play. Obviously, not going to be a large part of anyone's portfolio, given the liquidity characteristics, but within a diversified set of risks, it's really interesting right now.

David Lebovitz: Yes, I totally agree, and that's something we illustrate in our Guide to Alternatives as well. So, maybe just to wrap us up here, where we've ended up is with a mix of assets that are biased towards growth, like keeping an eye on inflation.

We've given up some liquidity here, but we are enhancing the income that the portfolio would provide relative to, you know, having just stuck in more liquid parts of the capital markets, and we're being defensive around fixed income.

We continue to think that long-term rates are headed higher. And so, being active in managing your duration is going to remain of the utmost importance. I think from a return perspective, we end up in a better place than we would have with a traditional 60/40.

But Jared, to your point, earlier, you know, manager selection and alpha generation are going to be key because as we know in our long-term capital market assumptions, expected returns for risk assets remain under pressure.

And while rates are expected to normalize going forward, it's not like they're headed to the moon. And so, the thing as we look ahead is, the easy money has been made here, and it's going to be more challenging from this point forward. And so, I'll leave you all of this.

We hedge in portfolios against the risks that we can see. We diversify against the risks that we can. And I think where we've shaken out today is with a nice, diversified portfolio that can simultaneously address client needs, while protecting us from unforeseen events like, say, a global pandemic. So, Jared, as always, an absolute pleasure having you with us, and hope to get you back here soon.

Jared Gross:  Thanks very much, David. Take care.

David Lebovitz: Thank you for joining us today on JPMorgan Center for Investment Excellence. If you found our insights useful, you can find more episodes anywhere you listen to podcasts and on our website. Thank you. Recorded on December 2nd, 2021.

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