Adena Baichan of Markets Group recently approached Eric Teal on his thoughts about inflation, globalization, the higher rate environment, and streamlining investment offices, among other topical subjects. As an investment manager and managing director of U.S.
Bank, Eric Teal directs investment services and uses his experience to
manage equity portfolios, establish an integrated investment approach, and
offer asset allocation strategies.
Previously, Teal
served as the Chief Investment Officer and Managing Partner of Queens Oak
Advisors in Charlotte for over six years. He had accountability for the firm’s
investment strategies and results, including overall responsibility for asset
allocation and directing portfolio management, research, trading, planning, and
risk management functions.
Also active in
the community and committed to his philanthropic passions, Teal was appointed by
the UNC Board of Governors to serve on the PBS North Carolina, formerly UNC-TV,
Board of Trustees and was subsequently elected Chairman of the Board of
Trustees for the past six years and remains on the Board of Trustees. He
also serves on the Board of Trustees for The Echo Foundation, a global
humanitarian organization.
Adena Baichan:
What are some thoughts that you have as an
investor, specific to the region(s) you cover?
Eric Teal: My expertise rests in equity portfolio
management, but I have been responsible for leading dynamic asset allocation
programs over my career. Currently, I believe there is simply too much
concentration in the S&P 500; particularly in the FAANGs + Microsoft which
currently constitute well over 20% of the index again. The past six months have
been one of the narrowest markets in the last century. This harkens back to the
technology bubble and pandemic period but is now being fueled by artificial
intelligence and other emerging technological themes. This concentration
defeats so many of the standard diversification benefits that allocators preach
and elevates the unsystematic risk that can be better diversified using broader
benchmarks and strategies with different weighting methodologies. Today,
investors should seek out more diverse investment strategies as we have been
particularly narrow and top-heavy of late.
Baichan: What is your advice to other allocators on
what you are seeing, that is specific to your region or expertise?
Teal: Today, a lot of asset allocation programs look alike and have produced
similar returns. Many 60:40 portfolios remain overweight large cap stocks. Small
and micro-cap stocks tend to sell off more frequently than large caps, however
they tend to recover more rapidly from the drawdowns when coming out of a bear
market. Thus, as the economy slows down and potentially contracts and monetary
policy becomes less restrictive, allocators should look for opportunities
outside of the more concentrated large caps including small and micro-cap
stocks that are more domestically focused and likely to present greater
opportunity for active managers.
Baichan: How have you changed your allocations for the
year(s) ahead? (And Why?)
Teal: I have long
worried about mounting inflation as the unemployment rate hit historical lows
several years ago. The sticky components of inflation on the service side
remain difficult to rein in, hence allocations should continue to include some
exposure to companies and asset classes that can pass through costs and better
hedge inflation including gold, natural resource investments, and
infrastructure. Additionally, fixed income is presenting opportunities to
investors as short-rate increases are expected to moderate and investors are
finally being rewarded for not holding cash.
Baichan: Do
you have any tips on streamlining protocols at investment offices?
Teal: Avoid bureaucracy at all costs. Investing is a
nimble exercise, but not about market timing. Healthy skepticism and most of
all courage to invest in out-of-favor sectors and strategies have proved
rewarding over time. Larger organizations feel compelled to have products in
most investment categories and often have poor entry points when momentum and
trailing historical performance are high. Yet, studies routinely show
performance means reverts, and more assets under management and countless
products only erode alpha. Most organizations fear expressing that they do not
do something well, since it might imply incompetence. However, most investment
offices cannot do everything well, so it is best to define areas of expertise
and avoid or outsource areas that are not core competencies.
Baichan: How are you investing around the rising rate
environment?
Teal: Modestly adding to fixed income with higher quality and shorter duration
investments. Inflation remains sticky and the yield curve inverted, so a balanced
approach of risk-taking with defensive positions is warranted at this juncture.
Again, small caps are more leveraged to an economic rebound in cyclical activity
which seems like an emerging opportunity.
Baichan: How are you investing around Inflation?
Teal: Generally, by avoiding longer duration fixed income and underweight equity
sectors that are more rate sensitive. I am more focused on high-quality shorter
duration assets and equities with strong free cash flow and attractive
valuation. As rates have risen to combat inflation, growth has historically outperformed,
which has been the case of late, as rates stabilize and decline at some
juncture, expect for a resurgence in value-oriented sectors.
Baichan: How are you investing around globalization and/or
supply chain shortages?
Teal: Supply chain shortages are
temporary events and are difficult to capitalize on. Globalization trends have
started to reverse, as reshoring in semiconductors, medical supplies, etc. is
viewed as a national security priority. This probably does not end over twenty
years of globalization since China became a member of the WTO as there remains
a comparative advantage to trade, but multi-national companies are moving out
of China and building capacity in countries more likely regarded as allies.
Baichan: Can you discuss your investment philosophy
around energy investments? ESG? The just transition?
Teal: The Energy sector is modestly
attractive and led market performance in 2022, partially because of the prior
year(s) of underperformance, more disciplined capital usage, and the experience
of the current management teams. However, some energy companies are making
significant progress in “green” innovation.
Although we tend to focus on fundamentals and valuation, ESG credentials
and Just Transition principles continue to have an important influence on
company performance. As energy companies outperform and “embrace” ESG,
institutional investors and capital are likely to follow.
Baichan: What issues are you most concerned about /
what keeps you up at night?
Teal: Most recently, what has happened in the banking system among the
regional banks elevates the chances of a recession over the next six months.
Banks tend to be a cyclical sector and historically have underperformed during
weak periods of economic growth. All FDIC-insured banks have been impacted by
the recent bank failures and outflows of deposits. However, there has been
minimal evidence of credit issues, and banks are currently better reserved with
stronger balance sheets than during the 2007-2008 period. Although there is
likely more earnings impact, regulatory fallout, and commercial real estate
unknowns, an opportunity is likely forming. However, timing is important within
the financial sector for investment success.
Baichan: Considering your area of expertise, what
improvements would you like to see in our industry?
Teal: With the onslaught of so many asset allocation programs like target
date funds, robo advisors, OCIO solutions, institutional consultants, etc. the
results have been modest compared to the traditional 60:40 balanced portfolio.
I believe clients need a better way to consistently evaluate performance,
particularly after fees, taxes, and trading costs versus appropriate benchmarks
and peer groups. The new SEC marketing
rules and GIPs Standards have made significant strides in this area and further
improve the ability of prospective investors to evaluate and compare results.
Baichan: What are your views on investing in emerging
markets?
Teal: Both offer diversifying opportunities but have important correlations
relationships with inflation. Emerging markets have often fallen victim to
inflation, and emerging countries are less homogeneous, so it is better to
identify strategies or managers that focus on countries or regions that offer
the best opportunity and have a proven track record of doing so.
Baichan: On investing in private equity and/or venture
capital?
Teal: Private equity firms have been exceptional business partners. Their returns
have been extraordinary over the last fifteen years and far above small-cap
public equities. As a result, the asset base has soared, and valuations are
lofty. Given the industry growth, public plan and endowment allocations, and
the need to produce high IRRs finding new opportunities will become
increasingly difficult given the sheer scale of the asset pool. Additionally,
the rising cost of debt financing could present problems as they are financed
shorter and have higher leverage than public companies.
Baichan: What are your current priorities for this
year?
Teal: My priority every year is to add relative investment value to our
clients’ portfolios. The market has recently been less favorable toward active
management, but I anticipate this to broaden across most asset classes.
Additionally, I hope to continue to build out our team and capabilities and
grow the business by building upon a track record of investment results.
Baichan: What is something that you have found
useful/helpful in the current economic environment?
Teal: Avoid momentum and performance chasing in this environment. Given the
increased volatility and shorter business cycle, it seems that styles and
strategies go in and out of favor more frequently. Hence, the prospects or fear
of missing out can lead to poor entry points and a lack of sell discipline for
investment managers and allocators resulting in weak performance.
Baichan: Any last advice to other allocators?
Teal: The economy has largely topped expectations and diverted a recession
eighteen months into the tightening cycle. As monetary tightening pauses,
expect the equity market to broaden – including small caps. However, if the
economy experiences a “hard landing” or significant multi-quarter contractions,
all stocks are in for a collapse in multiples– which is not currently priced
in.
Baichan: In the spirit of creating an allocator
community worldwide, what topics might you be interested in discussing with
other allocators? What might they call or email you about?
Teal: I am certainly interested in discussing the hot industry topics like ESG
investing, direct indexing, and the impact of AI with other professional
allocators. Additionally, I am excited about the professional opportunities
that lie ahead for active managers and their ability to demonstrate value to
clients through asset location and asset allocation planning as the industry
enters the distribution phase with Baby Boomers entering retirement and
opportunities more prevalent for income-oriented investors.
Interview by Adena Baichan