Alternatives Watch 2022 Outlook: FEG

Earlier this year we took some time to catch up with Greg Dowling, who serves as co-chief investment officer and head of research for FEG, which provides consulting and OCIO services to institutional investors.

He joined the Cincinnati-based firm in 2004 and today chairs FEG’s investment policy committee that oversees all manager hiring and firing decisions and approves all capital market assumptions. In addition to his work with the research team, he is also a member of the firm’s leadership team.

In this early-February interview, we are afforded a glimpse of how the firm is advising its clients to weather the uncertainty ahead.

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Over the next 12 months, how are you formulating your portfolio allocations? What is top of mind?

So far, we are defining 2022 as a year of “going back to basics.” Recent market pullbacks still have many sectors up 90% from lows. We believe there is less to do now and less opportunity means you should take less risk. Again, focus on the basics like rebalancing and diversification. Rebalancing portfolios may not lead to higher returns but is an important risk management tool. Our motto is: don’t let the markets rebalance for you. Next, diversification across asset classes and within asset classes will be important.

We are more heavily emphasizing real assets securities with inflation protection. Due to the lack of inflation in years past, investors may have let this allocation run down. For example, just having REITs will not do it.

Fixed income (broadly) remains a concern as yields are so low. With inflation and rising rates a concern, bringing in duration would be prudent. As a fixed-income replacement, one could consider diversified multi-strategy hedge funds.

Finally, most equities are somewhere between fully valued to overvalued. Investors could focus on ex-US opportunities like those in Europe and Japan, as valuations look better. In the U.S., energy and financials are sectors to watch. We’re not planning any ‘pound the table’ moves; when the market gives you a lot to do, take advantage of it. When there is less to do, don’t make mistakes.

As we approach the 3rd year of the pandemic, what are your thoughts about the macroeconomic picture?

Our starting point is still accommodative, but it will get more challenging as the year goes on, as we anticipate 3-4 rate increases this year. Also, fiscal tightening will be on top of monetary tightening, where 10% of GDP per year has been facilitated through emergency stimulus. Even if Build Back Better passes, that program amounts to pennies compared to the stimulus of recent years. The Fed may get tougher as the year goes on, but corporations, governments, and frankly many people are still flush with cash, equaling potential pent-up demand to fuel the economy. Hopefully, that will offset some of the fiscal and monetary drag. Some of the significant potential risks we see are obvious; for example, will we see another variant? Inflation and geopolitics loom large. Will the Fed err on monetary policy? We fully expect this to be a challenging year from a macroeconomic perspective.

What role do you see private capital playing in your portfolio going forward?

Private capital will continue to play an important role. Although we anticipate returns will be lower, they are still anticipated to be higher than public market returns. Take advantage of the wall of money. For one thing, what are private equity firms going to do with all of that dry powder? Lower middle-market real estate and buyout remain interesting, as a portfolio manager can always sell up the food chain. In a more crowded field, buy and build roll-up strategies remain feasible.

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