As the Federal Reserve begins to shrink its balance sheet and put an end to so-called quantitative easing, investors are concerned that this unprecedented process could negatively affect markets.
David Hunt, President and CEO of PGIM, Prudential’s investment arm, is one of those keeping an eye on it.
“I think that remains one of the big risks that investors face,” he told Business Insider’s deputy executive editor Matt Turner recently.
Turner recently caught up with Hunt, to ask him about central bank policies, stock markets, real estate, and more. PGIM has more than $US1 billion in assets invested around the world. Here’s what he had to say:
This interview has been lightly edited for length and clarity.
Matt Turner: You guys have over $US1 trillion in assets, with offices in 16 countries, so I wanted to first ask, when you look around the world, what do you see?
David Hunt: For us, the most important thing that we focus on is our investment performance. We believe fundamentally that investors — and most of our investors are long-term, sophisticated institutions, so pension funds, sovereign wealth funds, central banks — what they’re looking for from their investors is somebody who’s actually going to be able to beat their benchmarks and add excess return for them.
We’re an active manager, which you know has been somewhat unpopular recently, but we believe we’ve been a very successful one.
We’re an active manager, which you know has been somewhat unpopular recently, but we believe we’ve been a very successful one.
We’ve been successful because we do deliver real excess returns for our clients.
Turner: In terms of those excess returns, where do you see opportunities for investors? Where are your investment managers seeing an opportunity to make money?
Hunt: I would say the major thrust has been threefold. One has been for many institutional investors around the world, the race for yield has been incredible. We may not love the interest rates in this country, but if you are in Japan or you’re in Europe, all of that actually looks really good.
We’ve really been able to bring the search for yield home to many of those investors. Secondly, we’ve been very successful in finding real returns from real assets. By that, I mean real estate — both debt and equity — but also everything ranging from agricultural investment, infrastructure debt, and other real assets that are generating both income and capital gains.
Turner: When you look at US markets, how do you see what’s going on? Are there any opportunities at home?
Hunt: We absolutely believe that there are significant opportunities. And indeed, we believe that the US economy is in very good shape. We’ve actually recently upped some of our estimates for GDP growth. We would say the US is growing faster than its real potential GDP, which ultimately leads to a bit of an uptick in inflation, but at the moment we remain pretty optimistic.
We would say the US is growing faster than its real potential GDP, which ultimately leads to a bit of an uptick in inflation, but at the moment we remain pretty optimistic.
I would say the most important part of that optimism is based on seeing a return of business investment. Before, mostly it was on the consumer side, and businesses were leveraging but using a lot of that to buy back shares. In the last 18 months that dynamic has changed. Buybacks have come well down and we’re seeing real business investment into this country. We like that story on the equity side. We like what a lot of that means for fixed income and higher-yielding fixed income. We remain very constructive on most aspects of the real estate sector, maybe with retail as an exception.
Turner: On the equity side, you said earlier in the year that the stock market had maybe gotten ahead of itself in terms of betting on the success of various administration policies that might give the economy a boost. Where are we now? Obviously, a lot has changed since last summer. It seems like things are changing every day. Where are we now?
Hunt: It’s a very interesting thing in terms of the market sentiment. At the beginning of the year, there was without a doubt the famous Trump trade that came on, which was a belief in tax cuts, infrastructure, and deregulation as a package driving growth. We saw over the first quarter and second quarter, that trade really went to zero. The basic belief that that would happen diminished a great deal in investors minds.
Of course, at the same time, the real economy — in a sort of different, parallel universe from politics — was doing even better, so real growth rates were picking up and a general belief that the economy was doing better began to take over market sentiment. I’d say the market was driven higher by that belief, not really related to the Trump policies. Now in the last two weeks, we’ve started to see that shift again. I do think that with the at least outline of a tax plan on the table, you’ve begun to see some of the Trump trade animal spirit come back in. But for most of the year, I would say that hasn’t really been a factor in the markets.
Turner: We talked about the opportunities. Where are there risks? Particularly, in my conversation with investors, a lot of people talk about the Fed and there being the uncertainty around who might lead it, and whether they might raise rates or move too soon. So how do you see that dynamic?
Hunt: There’s no question that we have real policy risk. I mean, never before in the last thirty years have we seen so much of economic activity dependent on, not just the Fed, but I would generalize it to central banks around the world and the very accommodative policies. So there is a lot riding on the fact that they can begin to normalize those policies in an effective way. And that isn’t just when they decide to raise rates, and at what pace, but also what they do with the balance sheet.
One of the big challenges for the Fed is going to be at what pace they begin to unwind that balance sheet, and I think that remains one of the big risks that investors face.
Turner: One of the research notes that I received this morning made the point that monetary policy is going to dominate stock trading for the near time. Do you agree with that? Or do you think there’s more to the story than that?
Hunt: I think that there is quite a bit more to the story. There’s no question that it today’s valuation — if you look at the S&P overall, forward PE’s are about 18.5, the long-term average is more like 15.5 — you could say that it looks a little bit rich. But at today’s interest rates, actually, it looks pretty fairly priced. If we had a sudden rise in rates you would begin to think probably that the current prices are, without a doubt, a touch frothy. But we would not say that’s the base case. We actually think the base case is that we’re quite constructive on equities at the moment, but we do think that the risks of a gradual normalization remain around the balance sheet of the Fed.
Turner: Going back a step, you mentioned the Japanese market and Europe. Outside of the US, where do you see opportunity? You mentioned India as well.
Hunt: There’s no question we would certainly have Japan at the top of our list. We do believe that there are large institutional investors there who are looking very actively to put their money to work outside of Japan and to move into higher-yielding assets. I would have said that their search for yield 1.0 was to move into the US and to move to kind of investment grade corporates. We’re now really seeing a search for yield 2.0, which has to do with high-yield, emerging markets, and structured products, which as you know, we hadn’t seen for quite some time from the Japanese. We do believe that there is a lot more yet to run on the movement of money out of Japan.
Turner: Just turning to the money management business for a moment, the industry is changing dramatically, what’s going on there and how does the search for yield fit into that?
You’re seeing the rationalization of managers, you’re seeing fees come down for many types of products, and you’re seeing the continued growth of passive.
Hunt: The money management industry is absolutely reflecting the pressure that the clients are facing. In this very low return environment, you think about what the big institutions are doing. One, they’re very worried about fees, so there’s a real focus on that. Two, they’re wondering where should they pay for active management, which is more expensive than indexing, and what should they index, where they just want to buy cheap beta. And three, how many managers should they be working with? Many of them have a large roster of managers, and is that really the most effective way to manage a full portfolio? So you’re seeing that play out right now across the industry. You’re seeing the rationalization of managers, you’re seeing fees come down for many types of products, and you’re seeing the continued growth of passive.
Turner: One of the things that people in the industry often talk about when it comes to money management is this barbell, where as you said you have low-cost, passive index tracking funds and at the other end you have higher fees, higher active share, things like private debt which you mentioned, and it’s those in the middle that are charging higher fees for something that looks quite a lot like beta that are really going to struggle. Is that what we’re looking at?
Hunt: Yes I would very much subscribe to that. I think that firms that are charging high active share prices but delivering something that really actually hugs the benchmark are going have a very difficult time. That’s just fine. I actually think that’s competition that is leading to investors having a better proposition. I do believe investors over time will, instead of saying ‘is it active or passive?’, will say ‘how can active and passive work together?’ so we have cheap beta where that makes sense. There’s plenty of room to run with active management on all kinds of other strategies where you’re going to need that excess return if you’re going to pay for retirement over twenty years.
Turner: In terms of those strategies that do offer excess return, which of those are you pushing into? Would there be acquisitions that might make sense to accelerate your growth in those areas?
We see lots of room around specialist strategies like biotechnology and senior housing.
Hunt: Well currently we would say that we have most of the strategies that we need to do that. For us, we are such a big player in real assets. That is our real estate business in particular, both debt and equity, that’s a lot of where we see excess returns coming from active management. But we would say the same thing in fixed income. We’re the fourth largest fixed-income business in the world and we would say that that business is fundamentally one where active management makes a lot of sense. So for the passive piece of this we’re really just talking about equities. We think the US equity markets will continue to gradually move more to passive, but we see lots of room around specialist strategies like biotechnology, senior housing type things, and we see plenty of opportunities in international and emerging markets where active management adds very significant value.
Turner: You’re one of the biggest players in real estate. Where is there an opportunity for investors to make money?
Hunt: What we’re seeing from investors’ point of view is a little bit of a recalibrating of their risk. We do see demand for core going up quite a lot, and probably a little bit less in terms of demand for a real opportunistic. Core Plus also been a very popular. Within the sectors, we see a very large demand for logistics, for multifamily, which has continued to be one of the important pieces. We do think hotels are probably a little bit overdone and we’ve been selling in some selective, large kind of gateway cities. By and large, we still believe that the supply-demand dynamics in real estate mean there’s plenty of excess returns to be had.
Turner: You mentioned the bond market. Earlier in the year there was definitely a sense that the stock market was saying one thing about the economy and the bond market was saying another. Is there a tension there, and has it been resolved?
Hunt: It hasn’t necessarily been resolved in so much as just come into an equilibrium. I do think, as you put it before, that the equity market does rely on us having somewhat lower rates and the Fed normalizing policy fairly gradually. I think if that plan does play out, you probably have a pretty even balance of risk and reward. The important thing to recognise about interest rates is that the Fed only really controls the short end. We believe that there is so much money looking for a home in fixed income, that actually there will continue to be money that comes into the middle part of the curve and the longer part of the curve. That’s going to mean it’s going to flatten, and that’s happened quite a bit already this year. We would expect it to happen even more. Just because the Fed raises rates doesn’t necessarily mean that will happen uniformity, and I think that’s important for your viewers to realise.
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