The Chicago-headquartered bank is overweight fixed income and underweight global equities in developed markets. It also says a big asset allocation shift to "alternatives" seen in the past 20 years has slowed, if not yet reversed, while bonds are back in fashion.

Caution is the watchword and bond markets are back as attractive portfolio holdings, while a drive of wealth into alternative assets appears to be slowing. 

These appear to be takeaways from the 2024 global outlook from Chicago-headquartered Northern Trust last week as it guided journalists about its thinking.

Northern Trust is overweight fixed income (neutral on investment-grade debt), overweight on high-yield paper, and underweight global equities in developed countries. Its positioning appears to be broadly in line with many of its peers in an uncertain economic and geopolitical environment. 

The attractions of fixed income – as yields have risen – have led to a rethink about asset allocation, and the place of alternatives such as private equity and credit. It is a shift taking place as central banks have turned off the monetary taps after more than a decade of quantitative easing. The US Federal Reserve’s primary rate is 5.5 per cent, and paper such as the US Treasury 2-year bond yield is 4.3 per cent. With such low-risk paper delivering yields such as this, the attractions of going up the risk curve to obtain yield isn’t nearly as urgent as before.

While not just driven by yields, a shift into private equity, venture capital, private credit and real estate has been a dominant theme since the 2008 financial crash and up to the pandemic. Bonds fell out of favour as portfolio “ballast.” Instead, ideas such as the Yale Model approach – holding large pools of illiquid assets such as VC – became the new hot trend.

But there appears to be a change under way, at least to an extent.  

"They [investors] are not coming off alternatives but they are not continuing to increase," John McCareins, head of international and leads Northern Trust Asset Management's business in Europe, the Middle East, and Africa (EMEA) and across the Asia-Pacific, said. 

His colleague, Eric Williams, senior portfolio manager and head of credit at the firm, said a shift was taking place in the fixed income side. “Private [market] asset allocation was increasing for quite some time and clients are coming to us for solutions to balance that. The [monetary policy] regime shift is producing an opportunity,” Williams said. “It [fixed income] is in an entirely different environment [now] with prospective returns and downside capture.”

From 2010 to 2020, a period of very low interest rates encouraged leveraged buyouts, boosting returns on equity via buybacks and debt. Today, however, the focus is now on companies’ balance sheets, Williams said. High-yield debt yields are “extremely compelling” on a risk-adjusted basis, at about 90 cents in the dollar, he said. “Investors have opportunities to get yields that are only reserved for crisis periods.”

Northern Trust’s outlook considers how the much-discussed “60/40” portfolio split (equities/bonds) fares – sometimes this split is pronounced as out of date. The US bank looked at returns of such portfolios and how they compared with specific inflation targets – a rolling inflation target; a moderate target of 2 per cent, and a target of 5 per cent. The “hit ratio” – the percentage of time such portfolios exceeded these targets – ranged from 64 per cent to 73 per cent for the shorter rolling periods.

Over longer periods, the portfolios achieve a range of 81 per cent to 98 per cent.

Scenarios
Northern Trust has three scenarios for 2024: A soft landing (cooling growth and inflation that matches central bank forecasts), a “goldilocks” outcome (faster-than-expected falls in inflation and an earlier move to rate cuts), and recession. “Looking at the available data, we see our first scenario, `soft landing,' as the most likely outcome for 2024, with real GDP growth in the range of 1 to 1.5 per cent and inflation continuing to abate,” it said.

As a result of this shift, the bank is going out into the market to build out its fixed income teams and expertise, McCareins said. He pointed out that Northern Trust works with about 500 family offices. It is continuing to build its services/offerings for such clients, and is planning to do more in this segment outside the US market.