Guest Q&A With Jack M. Nelson, PhD, CFA
Jack Nelson is a very busy man if how long it took to schedule this interview is any gauge. The reason, of course, is that Jack is one of the savviest and well-regarded CIO’s in the business and consequently his plate is pretty full. We are fortunate and appreciate the opportunity to speak with him just in time to meet our deadline for this Q4 edition. Here is the conversation we had on a recent Friday afternoon.
IAUM: Jack, what is front-of-mind as you survey current market conditions?
NELSON: Three things come to mind: 1) How do we increase our investment income while managing our risks? 2) What is the Fed going to do and what are the implications? and 3) When does the equity market ride end?
IAUM: Let’s take those one at a time. Increasing investment income. What are your thoughts?
NELSON: Most insurance companies have already gone down in credit to capture more yield. Spread compression bears that out. Spreads may have bottomed but they are still very tight. Liquidity was the last tool for obtaining more yield. While the private debt trade feels crowded, we think it is better value than the public markets.
IAUM: What are your thoughts on the Fed? They are in a tough spot between low unemployment, increasing inflation, uncertainty over tariffs and taking fire from the president.
Low unemployment, uncertainty over tariffs and taking fire from the President may cause them to raise the funds rate more slowly. Some early signs of increasing inflation and accommodating monetary policy would make the Fed more inclined raise rates. The market believes the Fed will slow the pace of increase during 2019 and that we should expect another increase or two after December of this year.
NELSON: We spend a good deal of time thinking about this and there are many variables to consider. We have kept the duration of our investment grade portfolio slightly short of the duration of our liabilities as rates have increased. Being short duration has resulted in a return on the portfolio exceeding the return of the Aggregate IG Bond index by a healthy amount. That strategy has worked well for us and we will continue to take only modest positions on duration. We may recently have had some good news regarding the trade war with China that when coupled with an uptick in inflation may motivate the Fed to continue with its indicated path toward higher rates. Offsetting that to a degree is that inflation is still low and is generally projected to just move above 2% in 2019 despite extremely low unemployment rates, and the comments of the President regarding the Fed Chair. Because of the uncertainty we will continue to the modest use of duration to enhance returns.
IAUM: You mentioned your duration target. Is it closely tied to your liabilities?
NELSON: It is referenced to our liabilities but not strictly tied to them.
IAUM: Let’s shift to equities. You mentioned the long upward ride in the equity markets. What are your views of the current market and your allocation to equities?
NELSON: I have been here for nine (9) years and when I joined we didn’t have an allocation to public equities. Shortly thereafter, we made an allocation to dividend-oriented equities because they were yielding more than our IG bond portfolio. Our strategy was to pick up yield with an option on equity upside. While the trade initially worked well, over time, it faded and we have moved to a total rate of return approach on our equities.
IAUM: Do you think the markets are pricing in a recession?
NELSON: No, not at the moment. The markets appear very nervous but I do not believe the pricing reflects an expectation of a recession.
IAUM: There has been a big shift to passive from active equity management. What’s your thinking there?
NELSON: We view it differently depending on the segment of the equity market. We used to exclusively use active management of equity portfolios. Currently we are passive investors when investing in large cap stocks. The market is very efficient and difficult to outperform, net of fees, over time. We think that active management makes sense in less efficient market segments like small cap , global, and emerging markets.
IAUM: What about credit spreads?
NELSON: It feels like credit spreads may have bottomed and it appears they are widening. Corporate profitability looks good in 2019 but will be challenged to show growth because the tax cuts will be in the 2018 results.
IAUM: What about other factors?
NELSON: Geopolitical risks are the obvious ones. It is difficult to tell what tariffs will actually be enacted and how they will impact corporations. Brexit continues to have its own drama, and some bad actors continue to make it difficult to keep the peace.
IAUM: Is there anything that looks rich to you, “sticking out” if you will?
NELSON: To me, Class A office looks frothy depending on the market. New York for example, with the Hudson Yards project under development, feels rich. Other metropolitan areas in smaller cities are not as rich, for example Nashville.
IAUM: What about in-sourcing vs. out-sourcing?
NELSON: We outsource almost everything except about $300 million in equities.
IAUM: Where is Everest’s new money going now?
NELSON: As I mentioned prior, the private fixed income trade is feeling more crowded but we still think there is better value there than in much of the public debt alternatives.
IAUM: Jack, thank you so much for taking time out of your busy schedule to talk with me. It’s been a lot of fun.
NELSON: My pleasure, have a great evening.