We talk to Hirtle Callaghan, a firm that manages money on behalf of clients such as family offices, foundations and other organizations. It argues that as rates have risen, it creates opportunities for sectors such as private credit. As for wealth structuring, charitable remainder trusts can flourish in this environment.

Rising rates and the aftermath of 2022’s equity and bond market pain have encouraged outsourced chief investment officer Hirtle Callaghan to smile on areas such as private equity and private credit in its asset allocation mix.

And on the wealth transfer side, higher interest rates favor entities such as charitable remainder trusts (CRTs) for people who are charitably inclined and seeking to minimize income taxes, the firm told this news service.

With interest rates rising around much of the developed world, the investment chessboard looks rather different from the past 14 years of ultra-low or even negative interest rates. The old “60/40” equity/bond portfolios that have been the default stance for decades were slammed last year. And with the US Federal Reserve and others reversing quantitative easing, credit conditions are tighter. The demise earlier this year of Silicon Valley Bank, for example, was an example of what can happen for firms that aren’t prepared.

For the kind of clients Hirtle Callaghan serves, they build customized, globally diversified portfolios that meet long-term goals, and that must include protecting real wealth and in a tax-efficient way, Bill Hagan, who co-leads the Family Portfolio Management Group at the outsourced CIO, said. The firm oversaw $18.5 billion under management as of March 31 this year.

In 2022, the “ballast” in portfolios from bonds did not materialize and in times such as that, it was important to “lean in” to growth equity markets. “We have never really been anchored to the 60/40 portfolio. Our base case tends to be more growth-oriented at around a 70/30 level,” Hagan said.

A big consideration for clients is to have enough liquidity to manage their spending liabilities and needs so that they don’t sell out of a market at what would be a bad time, he continued.

“There is a still a role for fixed income in portfolios; it provides yield, liquidity and a ballast in some component of returns. With the Fed raising rates to 5 per cent we can get some return from fixed income again. The `safe’ part of a portfolio is able to be a much larger contributor to returns that we are seeking for our clients. The pain of old 60/40 portfolios has largely passed over the past 18 months,” he said. 

This news service asked Hagan what are the risks either on the upside or the downside that he thinks investors aren’t sufficiently focused on at the moment?

“A risk that investors face today is extrapolating current yields in cash and short-term fixed income well into the future. Investors are enamoured by the nominal yield offered in money markets and think they can meet their return requirement with low levels of risk,” he replied. “While short-term yields are higher today, so are inflation levels. To protect the portfolio from the impacts of inflation, having meaningful exposure to investments tied to economic growth remains critical.”

“If one sits in cash until rates move lower and plan to move into equities as rates normalize, the effect may already be reflected in equity pricing which may create an opportunity cost relative to long-term growth of the portfolio,” Hagan said. 

The rise of OCIO organizations such as Hirtle Callaghan speaks to how many family offices and institutions, for example, lack the time and resources to manage their investments, preferring to bring in experts. This publication has previously examined the world of the outsourced CIO here, and the need for a genuinely independent view.

Alternatives
Hirtle Callaghan is looking at alternative asset class areas such as hedge funds. “We will use hedge fund strategies from time to time although they tend not to be very tax-efficient and in recent years, their returns have not justified the high fees,” Hagan said. “We continue to take advantage of private markets and that is an area where it is worth the cost of manager access. For our family wealth clients, we work to get meaningful allocation to private equity.”

A benefit of private equity is that, on the whole, it tends to be a highly tax-efficient approach because of the long-term holding periods before the exits, he said. 

“We have been looking at the private credit space more and more,” he said, arguing that higher interest rates and wider credit spreads have created more opportunities in parts of the credit risk spectrum. As banks have pulled out of some lending activity it has also created a void that private credit investors can fill, Hagan said.

“We like the cash flows. Most pay a large share of total returns in quarterly cash flow and that helps clients to meet their spending needs,” he said.

Tax-efficient transfer and rates
A big part of what the firm does is guide clients on wealth transfer, mindful of how mistakes can cost clients millions of dollars if they don’t anticipate tax implications. In recent years, very low tax rates meant that devices such as intra-family loans and Grantor Retained Annuity Trusts could be employed successfully. 

With higher rates, families need to use different parts of the toolkit. 

One idea, Hagan said, is the charitable remainder trust. These offer an up-front charitable income tax deduction, as well as a vehicle for disposing of appreciated assets without immediate taxation on the gain. Also, unlike some strategies, CRTs become more attractive as interest rates rise. 

“If you can transfer wealth that’s subject to estate tax and save wealth, then the impact that advisors or a CIO can have on a family is extremely impactful,” Hagan said.