The article below is from our BRIEFINGS newsletter of 27 May 2021
Elizabeth Burton is the chief investment officer of the Employees’ Retirement System of the State of Hawaii, a $20 billion plan that serves about 135,000 people—or roughly one out of every 10 people in the state. At a recent Goldman Sachs Asset Management Forum, she spoke with Katie Koch, co-head of the Fundamental Equity business, and Mike Swell, head of Global Portfolio Management within the Global Fixed Income team, about her views on inflation, asset allocation and the role of private assets.
Katie Koch: Elizabeth, just to take a step back, how are you thinking about the current economic environment and specifically, what's your outlook for inflation? This is an area that we’re also spending a lot of time on, as we’re starting to see aspects of inflation in some of our portfolio companies and in sectors such as materials and shipping—though we’re not yet seeing inflation reflected in wages.
Elizabeth Burton: So in general, one of my biggest concerns is that we could see a spike in inflation. Even if investors broadly expect that inflation could hit 2% or 3%, there’s a larger confidence interval around those estimates than ever. Meanwhile, the amount of tax revenues coming into the government’s coffers is close to 75-year lows, even as the payouts are at all-time highs, so the growing budget deficit is certainly a growing concern. And when you look at three-year annualized returns across various sectors of the market, you can already see signs of higher prices. Agriculture prices, for example, have moved higher and you’re seeing higher prices across the commodities sector, given recent supply-chain disruptions. We think inflation is higher than what is currently priced in.
Mike Swell: We would agree with you, Elizabeth, that the range of outcomes around inflation has widened, and certainly the real question may come down to the impact that 2021 has on 2022 returns. How does your view of higher inflation impact your asset allocation strategy?
Elizabeth Burton: Currently, we prefer equities and are still in bonds, as there’s pretty strong evidence that bonds do better in lower-inflation environments. And because of where the markets have been and our own rebalancing requirements, we’ve had to keep rebalancing our equity holdings. So we’ve had to keep capital moving from equities into fixed income—such as long duration and TIPS—until we can invest more in private and real assets. We also think other regions, such as Europe—where, for example, the FTSE index is less weighted to tech—are looking more interesting, as are some value and quality assets, which also tend to hold up better in an inflationary environment.
Mike Swell: And how do you think about the role of private assets in your plan?
Elizabeth Burton: As a pension system, we’re long-term players and care more about the long-term trajectory than what’s happening day to day in the markets. I would say that we skew toward private-market assets. When I first got here in 2018, we had a roughly 8% allocation to private equity, and today it’s closer to 13%. In the Hawaii plan, we bucket our asset allocation into major risk factors, which has gotten us to thinking about investments in terms of beta and duration.
Katie Koch: We spend a lot of time on our teams thinking about how to set up our portfolios for an operating environment where cyclical stocks are likely to outperform in the short term as the economy opens up, yet technological disruption is creating a long-term deflationary impact across various sub-sectors. What’s your view?
Elizabeth Burton: In terms of innovation, I think many of the tech companies and innovations of the last 15 years are going to look very different going forward. I also think we’ll see innovations in different sectors, such as agriculture or in self-service consumer health. Overall, we have a low-risk equity book and we do have some funds that have more of a value tilt. As pressure to move into more ESG-oriented strategies mounts, many of those managers tend to have more of a value tilt embedded in them.