Absolute Return 2020 Outlook

The market backdrop in 2020 will be colored by election uncertainty, thorny trade negotiations and heightened geopolitical risks such as Brexit. And the macroeconomic picture is unclear as we’re seeing mixed signals in different parts of the world. We have already witnessed an unprecedented period of growth for U.S. equities with a 14% average annualized return for the S&P 500 over the last 10 years. Investors are now wondering if 2020 will be another leg in the longest bull market in history or a broad-based correction. To protect capital and provide diversified returns, we look for strategies that will be versatile in either market scenario. In 2020, we favor active managers that are able to reduce exposure, reallocate capital, capture alpha and generate uncorrelated returns through active management. During periods of market strength or sudden volatility, we believe it is prudent for clients to allocate to long/short equity, event-driven and private-market strategies that balance capital appreciation with structural and tactical downside protection.

As assets become mispriced, we believe global long/short equity funds will have opportunities to create alpha. Characteristically, the strategy’s combination of risk management and ability to adjust exposure through different levers—such as short positions and lower net exposure—during periods of volatility can generate diversified and less correlated returns that are more in tune with stock selection. Looking ahead, these types of long/short strategies can spot dislocations across sectors and industries. Long positions within high-quality companies that are industry first movers complemented with short positions in companies that can’t keep pace with disruption—“disruption pretenders”—can help mitigate pervasive thematic risks. On the specialist front, we think that utilities are a unique sector. Historically under-owned and under-followed by equity hedge funds and long-only managers, long/short utilities are an area where a manager can generate returns that have a lower correlation to traditional equity markets.

While U.S. economic data and corporate results may continue to trend upward, market volatility could be fueled by global macro and trade-related concerns. Event-driven strategies that rely on hard catalysts such as announced events can favorably capture consistent and absolute levels of return during challenging periods for fundamental value-based strategies. In market dislocations, event-driven strategies continue to rely on process-driven investments and can provide added diversification.

In private markets, we’re allocating to private equity, venture capital, private credit and real estate. More specifically, technology investing within private equity has offered an attractive investment profile for investors. Indeed, more companies are staying private longer. In venture capital, we have chosen to focus on managers that are looking to create value in a particular area of the global market, such as ESG investing. Across private markets, we continue to focus on opportunities within less crowded areas by partnering with experienced investors bringing a discerning valuation focused approach.

Within private credit, we’re being selective with how client capital is being allocated. We’re partnering with experienced teams that focus on security seniority and less cyclically exposed sectors. Given the increased inflow of capital into private markets, we believe valuation focus and credit underwriting will be critical. We expect yield-focused lenders—not credit-quality focused lenders—will face significant challenges as the credit cycle turns.

In real estate, one area we’re focused on opportunity zone investing, a new real estate investment program created by the Tax Cuts and Jobs Act of 2017. The program offers a chance for taxable clients to defer tax payments, reduce tax liabilities and capture development type returns on a tax-free basis for eligible real estate investments in certain geographic areas—if the investment is held for 10 years and other requirements are met. We’ve already seen many investors take advantage of the opportunity through a diversified real estate approach.

OAM Alternatives regularly meets with new managers across all strategies and asset classes to expand our breadth and understanding of the marketplace, having conducted more than 500 meetings in 2019. We’re strong believers that a combination of manager meetings and continuous education is correlated with better analysis and the expansion of the comparative universes we maintain. We have been focusing our due diligence efforts in equity long/short, event-driven and less liquid asset classes such as private equity, private credit and venture capital.

At Oppenheimer, we believe that an allocation mix of public and private investments offers clients the strongest avenue to generate consistent long-term returns. Global equity long/short strategies should continue to become a larger portion of clients’ equity allocation due to their ability to dampen volatility. A global equity long/short strategy was recently added to the OAM platform to offer investors exposure to U.S. and international equities. We continue to focus on event-driven strategies that offer investors steady uncorrelated returns, acting as a portfolio diversifier in the face of volatility.

M&A activity should benefit from any progress in the U.S.-China trade talks, which we expect to be resolved as President Trump bids for reelection. Within private equity and venture capital, we’re seeing opportunities with potential for upside that is not being captured in shrinking public markets. Finally, private credit continues to emerge as an uncorrelated stream of returns while banks struggle to overcome regulatory and yield-curve challenges. Private credit strategies present an attractive yield and risk/reward profile as investors seek the cash flow stability and low volatility that comes with the fixed-income portion of their portfolios.

Our platform offers a selective pool of co-investments that target unpenetrated value in various markets. We have identified companies with high potential for growing market share, an established customer base, continued capital reinvested in technology and expanding distribution channels. These opportunities include infrastructure, utilities, ESG, direct-to-consumer products and platform-based services.

In recent years, disruption has been top of mind for established players, new market entrants and investors alike. Specifically, we believe the disruption can provide opportunities for large companies to expand underperforming business segments or for smaller players with durable and growing business models to gain market share. Although disruption has been most prevalent within technology and health care in recent years, it isn’t isolated to these sectors. We believe that actively seeking innovative co-investments across the broader capital market and industries allows us to capture diversified returns.

In the coming years, we expect the number of co-investments on our platform to increase. They are a compelling way to diversify client portfolios through identifiable and discrete investments as opposed to a blind pool.

We recommend reducing or avoiding strategies that rely on significant leverage or broad market tailwinds. These strategies will be negatively affected if the market becomes volatile or declines precipitously as managers in this area may perform in stride with the market. A more effective strategy would draw on multiple sources of alpha.

We’re also cautious in our manager selection process. We focus on how managers are expected to behave amid volatility by considering the risk management processes they will invoke, the market scenarios that cause them to adjust portfolio exposure and how investment themes rotate given market changes. We prioritize managers who have a longer-term view on investment themes rather than managers that look for market corrections as an opportunity to execute on short-term themes. Often, we find that those short-term situations fizzle out in the aftermath.