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Table of Contents

Key Takeaways

The “When” and “Why” for Fed Rate Cuts in 2024

If the Fed Cuts, How Will Markets Likely React?

What if the Fed Doesn’t Cut Rates? Expect a “Muddle-Through” Economy

Lower but Not Negative Equity Returns in 2024 Without Rate Cuts

Assessing Potential Stress Points

Top Investment Ideas for 2024

KEY TAKEAWAYS

  • This upcoming year is likely to be the year of greater investor optionality and a much broader opportunity set. Indeed, we believe 2024 should have more compelling opportunities in store for investors than we have seen in the last two years.
  • If 2023 was the year of narrow market focus, in 2024 the opportunity set should broaden out across asset classes. Investors should have plenty of optionality to allocate across fixed income, real estate, venture capital, hedge funds and more.
  • The primary reason for that is that the Fed should cut rates in 2024 as inflation trends closer toward 2%, which could serve as a positive catalyst for the markets, offering equity returns worth staying for. Without the rate cuts, we expect a “muddle-through” economy and equity returns lower than 2023, but not negative.
  • While it still makes sense to remain vigilant, the current landscape doesn’t exhibit the same scale of systemic concerns as seen in 2001 and 2007. There are isolated areas of concern, but these pockets should not generate broad-based economic distress.
  • The prospect of the Fed reversing aggressive rate hikes may suggest a more inclusive equity market, benefiting not only the frequently touted “Magnificent 7,” but extending opportunities to a broader range of beneficiaries across sectors.1
  • In our 2024 outlook, we present our top investment ideas to meet various investment objectives, spanning both the public and private markets, which we believe are positioned to benefit from the anticipated lower rate environment ahead.

THE "WHEN" AND "WHY" FOR THE FED RATE CUTS IN 2024

The promising news for consumers and investors in 2024 is that it should finally be the year when inflation glides closer to 2%.

Core Personal Consumption Expenditures (PCE) inflation (the Federal Reserve’s preferred gauge) is expected to reach 2.5% by the fourth quarter – the first time since March 2021 or in roughly 15 quarters (Exhibit 1).2 That milestone is not only a relief for consumers, but it also signals a potential opportunity for the Fed to cut rates.

The Fed’s decision to cut rates in 2024 depends on three conditions: 1) confidence in a return to 2% inflation; 2) a sufficiently weakened economy needing support; and 3) market consensus or dislocation forcing rate considerations. We think that these three conditions are likely to be reached at some point in the second quarter of 2024, influenced by the following:

  1. Core PCE Inflation: Expected to reach 2.7% in the second quarter, with real rates rising to 2.3% as a result.3 This implies that real rates will be well into restrictive territory, 160 basis points (bps) above the Fed’s so-called neutral rate of 0.7%.4
  2. Real GDP Growth: Projected to be a mere +0.4% in the second quarter, and this continues to be revised lower.5 This represents a materially weaker pace than observed in 2023.
  3. Financial Distress Indicators: Defaults, delinquencies, and bankruptcies, which have all been on the rise, are expected to move higher in the first half of next year causing the Fed to think about cutting.

If we (and the consensus view) are correct on this assessment and the Fed does cut rates as early as May of 2024, how are the markets likely to react?

IF THE FED CUTS, HOW WILL MARKETS LIKELY REACT?

History suggests that the most favorable returns often precede the initial rate cut, specifically during the six-months prior to the cut.

Over the last six rate-cutting cycles since 1984, the S&P 500 delivered a median price return of +8.7% during the six-month period leading up to the first cut (Exhibit 2).6 Should history repeat, and the first Fed rate cut materializes in May of 2024 as the market now expects, market returns could continue to advance (building upon the strong gains seen in November 2023), as we progress through the first half of 2024.7

Viewing this from another angle, the median duration of the Fed holding rates before initiating cuts is about six months, with the S&P 500 delivering an average return of +9.2% during these prior holding periods (Exhibit 3).8 The bottom line is that the market is likely to welcome the first rate cut, and will price it in preemptively before the actual cut itself, with equities rallying. Those equity returns are likely worth staying for.

However, what happens after that remains unclear. Historically, equity returns following the first rate cut have largely been dependent upon the reason why the Fed was cutting rates in the first place. If the cut was preemptive before a recession, a scenario akin to the “soft landing” observed in 1995 could unfold.9 On the other hand, if the Fed was late and signs of economic stress had already surfaced, a “hard landing” scenario similar to the market selloffs in 2001 or 2007 could ensue.10

“This upcoming year is likely to be the year of greater investor optionality and a much broader opportunity set. Indeed, we believe 2024 should have more compelling opportunities in store for investors than we have seen in the last two years.“

We lean toward the former “soft-landing” scenario and envision a rate cut in the first half of 2024, which could serve as a positive catalyst for the market, offering equity returns worth staying for. Additionally, the prospect of the Fed, along with other major central banks reversing aggressive rate hikes may suggest a more inclusive market, benefiting not only the frequently touted “Magnificent 7,” but extending opportunities to a much broader range of beneficiaries.11 If 2023 was the year of narrow market focus, 2024 should provide many more opportunities for returns. In other words, investors should have plenty of optionality to allocate across various sectors and asset classes.

And fortunately, the current landscape doesn’t exhibit the same scale of systemic concerns as seen in 2001 and 2007. Although there are isolated areas of concern, these pockets should not generate broad-based economic distress – a topic we explore further in this outlook in “Assessing Potential Stress Points” section below.

And what about fixed income? U.S. treasury (UST) yields tend to fall across the curve following the end of a hiking cycle and through the first rate cute. In fact, the yield on the 2-year UST typically falls by roughly 85 bps during the six-month period leading up to the first cut followed by another 100 bps decline during the six-month period following the first cut.12 Similarly, the 10-year UST yield has historically fallen by roughly 75 bps and 50 bps during the six-month period before and after the first cut, respectively (Exhibit 4).13 If history repeats itself, the potential further decline in UST yields in 2024 (as markets price in rate cuts and slower growth), bodes well for future potential fixed income returns.

WHAT IF THE FED DOESN'T CUT RATES? EXPECT A "MUDDLE-THROUGH" ECONOMY

In the absence of early rate cuts by the Fed, we will likely see a “muddle through” economy in early 2024, marked by a shift in several factors that had previously bolstered consumption.

Notably, the decline in the personal savings rate from the 2020-21 pandemic average of 17.0% to 3.8% (Exhibit 5), and the dwindling excess savings of $148 billion (which is expected to be depleted over the coming quarters), are both poised to temper consumer spending. Additionally, forecasts indicate a more normalized and subdued wage growth environment, with wage gains slowing to 3.2% year-over-year (YoY) by the end of 2024, a sizeable decline from the robust 4.5-6% YoY growth seen since the pandemic.

Moreover, reduced credit availability and a reluctance to borrow at high rates could further curb spending impulses, contributing to overall consumption growth of just 1.2% YoY in 2024, a significant deceleration from the roughly 2.0-2.5% observed in 2023. Indeed, real-time consumer spending data has already exhibited a significant slowdown in the fourth quarter of 2023 relative to third quarter 2023 levels.

This potential deceleration in consumer spending, coupled with higher financing costs for corporations, may in turn exert downward pressure on corporate profit margins. And, in an effort to safeguard margins, companies may resort to measures such as layoffs or reducing job openings, therefore, yielding tepid labor wage gains and reinforcing the aforementioned deceleration in consumption.

Additionally, delinquencies, bankruptcies, and defaults are on the rise – a trend expected to continue through the early part of 2024 as rates remain elevated.18 Since the beginning of 2023, 591 U.S. companies have filed for bankruptcy, and 80 U.S. corporations have defaulted on their debt, already surpassing the 2012-2022 annual averages by 14% and 21%, respectively (Exhibit 6).19 And by September 2024, an additional 86 companies are expected to default, indicating a continued rise in default rates.20 For leveraged loan issuers, the default rate is anticipated to climb from the current level of around 5%, peaking at 6.7% in the first half of 2024, before moderating to 5.2% by the end of the year.21 High-yield bond issuers are expected to experience a peak at 4.6% in the first half of 2024, slightly exceeding the long-run average of 4%, and then settle to 3.5% by year’s end.22

A further uptick in these events would also contribute to slowing momentum in the economy as banks and investors absorb credit losses, employees face displacement, and corporate spending contracts. However, despite the economic headwinds posed by these challenges, it is anticipated that they will slow but not completely derail the overall trajectory of the economy, as discussed further below (in “Assessing Potential Stress Points”).

LOWER BUT NOT NEGATIVE EQUITY RETURNS IN 2024 WITHOUT RATE CUTS

All these factors lead us to expect a much slower economy in 2024 than in 2023, translating to more subdued equity returns as a base case, without the Fed rate cuts.

The significant returns of +19.0% for the S&P 500 and +35.9% for the Nasdaq Composite in 2023 (through Nov. 30, 2023) were driven by multiple expansion and resilient earnings.23 However, in 2024, we do not expect these dynamics to be a tailwind for equities. In fact, without rate cuts, there now exists a risk of downward earnings revisions. The prevailing sentiment does not align with an expectation of a slowdown judging from 2024 earnings estimates.

The 2024 bottom-up consensus earnings estimate for the S&P 500 has actually risen since mid-November to $246 from $242 previously.24  Assuming both the current 2024 S&P 500 earnings estimate and the 18x-20x price-to-earnings (P/E) multiple hold steady and the Fed does not cut rates, this would imply a current fair value of around 4700 on the S&P 500, effectively where the index closed post-FOMC meeting (Dec. 13, 2023) (Exhibit 7).25  However, the fair value is not static and is likely to change throughout the year. If the Fed in fact cuts rates, we could see upside to both multiples and earnings per share (EPS). And even without the rate cuts, as the year progresses, the 2025 bottom-up consensus EPS estimate of $275 should enter the fair value equation which at current suggest further equity upside.26 Of course, a recessionary development without rate cuts, could pressure EPS lower and with it, returns lower. Still, since we expect a “muddle-through” economy and eventual rate cuts, we see return potential in equities worth staying for, especially considering the likely upside from Fed rate cuts we outlined previously.

ASSESSING POTENTIAL STRESS POINTS

We continue to see no systemic risk lurking in the markets, although there are a few areas of concern worth watching.

To answer the question, what is likely to “break” given today’s historically high level of rates (at least in recent history), we have to size up the various “debt piles,” which we do in Exhibit 8. The assessment includes how much debt is outstanding in various borrower groups, how much of it is floating rate, and how much of it is coming due in 2024 (and will therefore have to be refinanced at higher rates). Problems and defaults arise when borrowers struggle to secure new financing, or when it’s economically impractical to re-underwrite debt at these levels of rates against the incoming revenues. With this in mind, three areas emerge as focal points of vulnerability: 1) U.S. government debt; 2) commercial real estate; and 3) 2021-22 ‘peak valuation’ private equity/venture capital vintages.

1) U.S. Government Debt:

The national debt now stands at a staggering $33.9 trillion, a nearly 50% increase in just four years.27 $26.3 trillion of that constitutes marketable debt, with a substantial $7.8 trillion maturing in 2024 (the equivalent to roughly 29% of the total outstanding marketable debt).28 As debt levels continue to climb, a significant portion requires refinancing at higher rates, causing interest expenses to grow substantially. Projections indicate this cost will double and reach record levels over the next ten years, rising from 9.7% of total revenues in 2022 to 15.4% in 2024 and 20.3% in 2033 — an alarming 200% surge from $1.3 billion to $3.9 billion per day (Exhibit 9).29  As a result, Treasury auction sizes are expected to increase 23%, on average, in 2024 as issuance ramps up.30 Over the coming quarters, we will continue to watch Treasury Quarterly Refunding plans and Treasury auctions.

Despite this escalating debt burden, a U.S. government default seems improbable. However, it could prompt rating agencies to reassess credit ratings, as witnessed in August 2023, when Fitch downgraded the long-term rating for the U.S. from AAA to AA+.31 And importantly, it may prompt investors to force government action, through higher risk premium demanded for holding U.S. Treasuries. The good news, however, is that there are ways to address this trajectory, with key opportunities arising before the end of 2025 when the Tax Cuts and Jobs Act (TCJA) tax cuts are set to expire.32

2) Commercial Real Estate (CRE):

Higher rates, coupled with declining property valuations, have impacted the commercial real estate (CRE) market, namely the office sector. Between 2024 and 2025, approximately $1.2 trillion, or close to 25% of all CRE debt, is set to mature, intensifying concerns about refinancing.33  Recent CRE loans have had an average interest rate of  6.5%-7.5%, up from 3.5% two years ago and 160-260 bps higher than the 4.9% average for 2023 maturing CRE loans.34 Fortunately, 90% of CRE loans maturing through 2024 can withstand refinancing at 6.5% while still maintaining a strong debt-service coverage (DSC) ratio of at least 1.25x (Exhibit 10).35

2024-Market-Outlook-Feature

“While it still makes sense to remain vigilant, the current landscape doesn’t exhibit the same scale of systemic concerns as seen in 2001 and 2007. There are isolated areas of concern, but these pockets should not generate broad-based economic distress.“

Of all the CRE sectors, we are most concerned with the office sector. The office sector accounts for 16% ($117 billion) of debt maturities in 2024.36 As of the third quarter of 2023, vacancies hit a new 30-year high of 18.4% and are expected to climb to 19.7% by the end of 2024.37 Delinquencies have also risen materially, rising roughly 440 bps to 6.1% in the past 12 months, though they remain below the GFC peak of 10.7%.38

Reassuringly though, the office CRE market isn’t expected to “break” the economy. Only 10% of U.S. office buildings account for 80% of occupancy losses between 2020 and 2022.39 And, office assets represent only 15% of overall CRE assets in the U.S.40, and a mere 2.4% of total physical assets (Exhibit 11).41 Additionally, while office debt accounts for 27% ($171 billion) of the current $636 billion commercial MBS debt outstanding, this is materially smaller than the 2007 residential MBS market, which stood at $2.7 trillion and served as the amplifier of investor losses spurring the 2007 global financial crisis.42

3) 2021-22 ‘Peak Valuation’ Private Equity/Venture Capital Vintages:

The backdrop of higher rates has presented challenges for both private equity (PE) and venture capital (VC), which have seen deal volumes fall -20% and -32% respectively on an annualized basis for 2023 compared to 2022 levels.43

Specific to private equity, the interest coverage ratios for private-equity portfolio companies have declined significantly since 2021 from 3.5x to around 2.7x as of March 2023, the lowest level since 2007.44 With base rates having risen to around 5.5% since March of 2023, coverage ratios have likely fallen to around 1.7x (Exhibit 12).45 This translates to interest costs consuming roughly 58% of the borrowers operating cash with base rates at 5.5%.46

“If 2023 was the year of narrow market focus, in 2024 the opportunity set should broaden out across asset classes. Investors should have plenty of optionality to allocate across fixed income, real estate, venture capital, hedge funds and more.“

The impact of declining coverage ratios is evident. Over 90 PE-backed companies have filed for bankruptcy year-to-date through November 30, 2023, representing 16% of total U.S. bankruptcies.47 It is worth noting however, that loans of PE-backed companies exhibited a lower default rate compared to those issued by companies without PE backing. The trailing twelve-month default rate for PE-backed loans is 1.45% as of November 2023, versus 2.69% for non-sponsor-backed companies (Exhibit 13).48 This is a testament to the strength of PE managers and their ability to swiftly adapt to shifting market conditions. And bolstered by a record $937 billion in dry powder, U.S. PE sponsors can deploy capital effectively to support portfolio companies, mitigating escalating stresses.49

Shifting focus to venture capital, fundraising has plummeted -67% in 2023 on an annualized basis compared to 2022.50 This fundraising shortfall hampers the ability of unprofitable companies from receiving additional funds to stay afloat. This could be a particular challenge for VC-backed companies within 2021-22 vintage funds, which raised capital at peak valuations. While companies have taken measures to cut costs and reduce burn of funds over the last year, some companies may still need to turn to venture capital as time goes on. Replenishing funds in the current environment of lower valuations and reduced VC capital availability could be challenging.

Despite these challenges, the bankruptcies and defaults in the PE and VC space are not anticipated to be systemic. The total assets under management (AUM) for PE and VC in the U.S. amounts to roughly $4.4 trillion, which pales in comparison to the $11.9 trillion residential mortgage debt outstanding.51 And, extrapolating from fundraising levels, 2021-22 vintages represent roughly 25% or $1.1 trillion of that total U.S. PE & VC AUM; however, of course, not all of those funds were invested during those peak valuations and funds from other vintage years might have been.52 Finally, the vast majority of investors are large institutions, shielding most individual investors from potential downside here.

TOP INVESTMENT IDEAS FOR 2024

Growth

   1. Venture Capital (Newer Vintages)

   2. Unprofitable Tech

Income

   3. Direct Lending

   4. Real Estate Debt

   5. Municipal Bonds

Diversification

   6. Macro Hedge Funds

Protection

   7. Structured Investments

   8. Annuities

In summary, our baseline expectation for 2024 is modest U.S. equity returns, with the potential for a bullish catalyst if the Fed cuts rates early (during the first half). While the exact timing of the rate cut remains uncertain, we are reasonably confident it will happen in 2024. We do expect some areas of dislocation if rates stay sufficiently high as outlined above, but with that as a backdrop, here are our top investment ideas to meet various investment objectives, spanning both the public and private markets, which we believe are positioned to benefit from the anticipated lower rate environment ahead.

GROWTH

1. Venture Capital (Newer Vintages):

In the private markets, despite our moderate concerns about the 2021-2022 peak valuation venture capital vintages (as outlined earlier), venture capital is still very much at the forefront of investing in new technologies that will shape our lives in the future. Newer vintage funds are poised to continue to invest in this innovation, benefiting from numerous secular tailwinds, including increased technology adoption and private companies staying private longer. These tailwinds help private companies capture a larger portion of gains than public markets.53

Strong trends persist in sectors such as cybersecurity, driven by geopolitical tensions and growing concerns for personal security in our increasingly digital lives. Artificial intelligence, while a focus of venture capital for years, has been catapulted to the forefront driven by the success of ChatGPT by OpenAI (founded in 2015). Early-stage venture, in particular, is a long-duration asset, and despite macroeconomic volatility, great companies emerge in all market cycles, as seen with Airbnb (2008), Slack (2009), WhatsApp (2009), Uber (2009), and more.

In 2022, valuations corrected materially, and although still elevated compared to historical levels, we view this as an attractive entry point given commitments to venture capital funds today will be allocated over the next 3+ years.54 In particular, we continue to believe early-stage provides the most attractive risk/reward setup within the venture capital ecosystem. Early-stage investments (which are typically before Series B) are often focused on identifying product-market-fit and scaling; this stage of investment often carries a lower degree of valuation risk compared to late-stage and venture growth investments.55 Pitchbook’s latest Venture Capital Dealmaking Indicator underscores the recent shift to a more investor-friendly environment, marking the best conditions going back to at least 2010 (Exhibit 14).56

2. Unprofitable Tech:

In the public markets, unprofitable tech, which has underperformed notably, could be a significant beneficiary of Fed rate cuts. For instance, the Goldman Sachs Unprofitable Tech basket underperformed the Nasdaq 100 by roughly -53% (percentage points) since the end of 2021 (through Nov. 30, 2023), influenced by rates and a perceived lack of quality (Exhibit 15).57 The prevalent “there is no alternative” sentiment led investors toward the Mega Cap Tech as opposed to the unprofitable tech space.58 However, that could change with rate cuts as these “long duration” equities, akin to bonds, may benefit from lower rates.59 And investors may feel less pressure to hide out in only the highest quality tech names. It’s important to note that market sentiment can quickly change, so we view this as a tactical opportunity to be closely monitored throughout the course of the year.

INCOME

3. Direct Lending:

Following the significant rise in interest rates, direct lenders in the private market are benefiting from greater absolute yield levels and improved risk-adjusted returns. Currently, lenders have the potential to achieve yields exceeding 12%, as spreads range between 550-700 bps above the Secured Overnight Financing Rate (SOFR) base rate of 5.3%, and original issue discounts average 2-3%, amortized over three years.60 The yield on the Cliffwater Direct Lending Index (CDLI) distribution yield has risen to 11.57%, up from 8.7% in the first quarter of 2022 and 10.96% in the first quarter of 2023.61 Additionally, lenders can generate these yields with reduced overall leverage (debt/EBITDA) and lower loan-to-value ratios, indicating a greater equity cushion. In fact, average private equity debt/EBITDA multiples have decreased 5.1x as of September 2023 from 5.9x in 2022 and are now below the 10-year average of 5.7x (Exhibit 16).62 Furthermore, equity sponsors are investing a greater amount of equity into new transactions, with the amount of debt financing for private equity deals dropping to 43.9% from 50.8%.63 Investors may consider capitalizing on the increased yields with favorable terms for new loans, focusing on established investment managers who have strong relationships with repeat borrowers and have demonstrated a disciplined approach to underwriting. And even if the Fed does cut rates in 2024 resulting in lower floating rate coupons, the yield advantage of direct lending should still be significant, considering an average interest income yield of 10.79% since inception (2005).64

4. Real Estate Debt:

The Federal Reserve’s continued hawkish policies not only resulted in high interest expenses for existing CRE borrowers, but also acted as a catalyst to the regional banking crisis earlier this year. Regional banks are a leader in providing capital to CRE borrowers, with approximately $2.3 trillion in CRE debt held by smaller banks. As regional lenders pull back capital, a meaningful gap forms between supply and demand for lending capital within real estate, which includes $1.2 trillion in CRE loans maturing within the next two years (Exhibit 17).65 Also, elevated rates have affected new issuances for CRE senior mortgages, resulting in SOFR + 400 bps loans yielding 9%,66 a favorable comparison to real estate equity as evidenced by both NCREIF ODCE’s one-year total net return of -13% and ten-year return of 7%.67

In this context, we see private real estate credit as a potentially attractive investment opportunity, benefiting from factors such as: 1) seniority to real estate equity providing structural downside protection; 2) floating rate debt that provides both limited duration risk and higher yields during high interest rate environments (even if the Fed cuts rates, we expect rates to stay above post-GFC averages); and 3) low correlation to other alternative investment asset classes. In our view, experienced real estate debt managers will be able to fill the gap created by the pullback in lending from regional banks while taking advantage of an interest rate environment that is providing very attractive returns.  Adding an allocation to real estate credit will not only diversify away from other, more volatile, opportunities, but also provide meaningful income within an investor’s portfolio. 

5. Municipal Bonds:

These publicly-traded bonds may produce high single digit returns if rates (and yields) decline. Considering the last five rate-cutting cycles since 1989, yields on 10-year municipal bonds (munis) typically fall around 40-50 bps during the six-months leading up to the first cut, followed by another decline of around 30 bps in the six-months following the first cut.68 Assuming muni yields fall 100 bps from current levels, this could imply a potential 12-month price return of +5.1% for 10-year munis, translating to a +8.1% total return when factoring in the 3.0% yield (Exhibit 18).69 And given munis are typically tax-exempt, the taxable equivalent yield of 5.0% could provide further upside.70 Additionally, if Congress does decide to reign in the budget deficit by potentially raising taxes and/or letting the prior tax cuts lapse (as scheduled at the end of 2025), the tax advantages of munis may become more valuable. On top of that, the finances for municipalities are in far better shape (on the aggregate) than the federal government.71

DIVERSIFICATION

6. Macro Hedge Funds

After a decade of “macro doldrums,” we are a couple of years into a far different market paradigm as it pertains to global rates, market volatility, and macroeconomic and geopolitical uncertainty. Historically, these factors have created an opportunity-rich environment for fund managers specializing in shifting market conditions across stock, bond, currency, and commodity markets.

Hedge funds, specifically macro strategies, have generally performed far better during periods of higher interest rates and market volatility (Exhibit 19).72 Consider a few examples: Since the start of 2022, the Japanese Yen has reached a 40-year low against the U.S. Dollar, the price of oil has fluctuated by (+/-) 35% on three separate occasions, and the relationship between publicly traded stocks and bonds has completely inverted, meaning that every month when equities fall, fixed income has declined in tandem.73 Meanwhile, macro hedge funds have delivered positive performance when traditional assets appreciated and provided downside protection when they depreciated.74

While central bankers may indeed cut rates in 2024, the probability that rates fall back to near-zero anytime soon seems, in options terminology, deeply out-of-the-money. If history is a guide, elevated rates portend more opportunities for all hedge funds, and most notably the more diversifying strategies such as global macro. And if 2024 shapes up to be tougher than we and consensus expects, macro strategies can be a helpful shock absorber, providing low correlation to the traditional 60/40 allocation.75 For instance, amid the three-month downturn for equities from August to October 2023, macro strategies, proxied by the HFRI Macro Asset Weighted Index, recorded a gain of +4.4%, while the S&P 500 incurred a loss of -8.6%.76

PROTECTION

7. Structured Investments:

While we anticipate that the Fed will begin cutting rates in the first half of 2024, short-term rates are still expected to remain elevated compared to prior cycles, providing an attractive environment for structured investments. Structured investments typically combine a zero-coupon bond, which pays no interest until the bond matures, with an underlying options package that provides the product’s market exposure. When rates are elevated, the price of the zero-coupon bond is further discounted, allowing for more funding to be deployed in the underlying options package and providing investors with more attractive terms. For example, we are seeing five-year structured notes with full issuer protection linked to traditional U.S. equity indices (such as the S&P 500) offering one-for-one upside participation, with a max return ranging from 50-60%.77 These types of principal protected  structures may be particularly of interest to investors seeking broad equity exposure, while maintaining full downside protection in the event of market volatility.

In addition, we are also seeing opportunities for portfolio diversification through structured investments linked to a broad range of quantitative investment strategies (QIS). QIS are systematic, rules-based indices that provide exposure to different themes, portfolio management strategies, and/or asset classes through a single investment vehicle. For example, certain QIS indices may seek to generate returns with low correlations to stocks and bonds, while others may seek to capture improved risk-adjusted returns compared to traditional benchmarks by controlling volatility. Investors can gain exposure to QIS through structured investments, providing an efficient way to add diversification to an investment portfolio.

8. Annuities

The focus on protection has remained key for annuities. Through the first nine months of 2023, total annuity sales have reached a record $270.6 billion, marking a 21% increase from 2022.78 Notably, $178.1 billion, equivalent to two-thirds of annuity purchases, flowed into fixed rate annuities or fixed indexed annuities (FIAs)—the two types providing 100% downside protection.79

According to U.S. Census Bureau projections, 12,000 baby boomers will turn 65 each day in 2024.80 With a greater percentage of the population reaching retirement age, we expect investors to remain focused on protecting their retirement savings. With interest rates still close to multi-year highs, the demand for investment solutions offering reasonable returns with 100% downside protection is expected to grow.81 In this heightened rate environment, five-year fixed rate deferred annuities continue to offer guaranteed rates in excess of 5.0% per annum, tax-deferred.82 And if investors are willing to trade-off a fixed guaranteed rate for a return tied to the S&P 500, they can increase their potential upside, with annual cap rates in the double digits.83 With the prospect of rate cuts on the table in 2024, we believe it is time to consider locking in today’s rates while you still can.

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VIDEO COMMENTARY

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INDEX DEFINITIONS

Bloomberg Global Aggregate Bond Index: A flagship measure of global investment grade debt from a multitude of local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.

Bloomberg U.S. Municipal Bond Index: Measures the performance of the USD-denominated long-term, tax-exempt bond market with four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-funded bonds.

Cliffwater Direct Lending Index (CDLI): An asset-weighted index of over 11,000 directly originated middle market loans totaling $264B. It seeks to measure the unlevered, gross of fee performance of U.S. middle market corporate loans, as represented by the asset-weighted performance of the underlying assets of Business Development Companies (BDCs), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements.

HFRI Fund Weighted Composite Index: A global, equal-weighted index of single-manager funds that report to HFR Database. Constituent funds report monthly net of all fees performance in US Dollar and have a minimum of $50 Million under management or $10 Million under management and a twelve (12) month track record of active performance. The HFRI Fund Weighted Composite Index does not include Funds of Hedge Funds.

HFRI Macro Index: Investment Managers which trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top down and bottom up theses, quantitative and fundamental approaches and long and short term holding periods. Although some strategies employ RV techniques, Macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments, rather than realization of a valuation discrepancy between securities. In a similar way, while both Macro and equity hedge managers may hold equity securities, the overriding investment thesis is predicated on the impact movements in underlying macroeconomic variables may have on security prices, as opposes to EH, in which the fundamental characteristics on the company are the most significant are integral to investment thesis.

HFRI Macro Asset Weighted Index: Investment Managers which trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top down and bottom up theses, quantitative and fundamental approaches and long and short term holding periods. Although some strategies employ RV techniques, Macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or future movements in the underlying instruments, rather than realization of a valuation discrepancy between securities. In a similar way, while both Macro and equity hedge managers may hold equity securities, the overriding investment thesis is predicated on the impact movements in underlying macroeconomic variables may have on security prices, as opposes to EH, in which the fundamental characteristics on the company are the most significant are integral to investment thesis. The constituent funds of the HFRI Macro Asset Weighted Index are weighted according to the AUM reported by each fund for prior month.

Morningstar LSTA US Leveraged Loan Index: Designed to deliver comprehensive, precise coverage of the US leveraged loan market. Underpinned by PitchBook | LCD data, the index brings transparency to the performance, activity, and key characteristics of the market.

MSCI World Index: Captures large and mid-cap representation across 23 Developed Markets (DM) countries. With 1,633 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

S&P 500 Index: The S&P 500 is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 of the top companies in leading industries of the U.S. economy and covers approximately 80% of available market capitalization.

ENDNOTES

1. Note: Magnificent 7 includes Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, and Tesla.
2. Bloomberg, iCapital Investment Strategy, as of Dec.13, 2023.
3. Bloomberg, iCapital Investment Strategy, as of Dec. 13, 2023.
4. Federal Reserve Bank of New York, as of May 19, 2023.
5. Bloomberg, iCapital Investment Strategy, as of Dec. 13, 2023.
6. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023. Note: analysis done on the last six rate-cutting cycles which include 1984, 1989, 1995, 2001, 2007, and 2019. Methodology used to define prior Fed cycles is based on the extent of rate hikes/cuts over a defined period.
7. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023.
8. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023. Note: analysis done on the last six rate-cutting cycles which include 1984, 1989, 1995, 2001, 2007, and 2019.
9. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023. Note: analysis done on the last six rate-cutting cycles which include 1984, 1989, 1995, 2001, 2007, and 2019.
10. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023. Note: analysis done on the last six rate-cutting cycles which include 1984, 1989, 1995, 2001, 2007, and 2019.
11. Note: Magnificent 7 includes Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia and Tesla.
12. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023. Note: analysis done on the last six rate-cutting cycles which include 1984, 1989, 1995, 2001, 2007, and 2019.
13. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023. Note: analysis done on the last six rate-cutting cycles which include 1984, 1989, 1995, 2001, 2007, and 2019.
14. Bloomberg, Bureau of Economic Analysis, iCapital Investment Strategy, as of Dec. 4, 2023.
15. Bloomberg, Bureau of Labor Statistics, iCapital Investment Strategy, as of Dec. 4, 2023.
16. Bloomberg, Bureau of Economic Analysis, iCapital Investment Strategy, as of Dec. 4, 2023.
17. Bureau of Economic Analysis, JPMorgan, BofA Research, iCapital Investment Strategy, as of Dec. 4, 2023.
18. Bloomberg, iCapital Investment Strategy, as of Dec. 4, 2023.
19. S&P Global, iCapital Investment Strategy, as of December 4, 2023. Note: Bankruptcy data is from S&P Global as of Nov. 30, 2023. Default data is from S&P Global as of Oct. 31, 2023.
20. S&P Global, iCapital Investment Strategy, as of Dec. 4, 2023. Note: Default data (and forecast) is from S&P Global as of Oct. 31, 2023.
21. Goldman Sachs, Moodys, iCapital Investment Strategy, as of Nov. 13, 2023. Note: Default rate is the trailing 12-month issuer-weighted default rate.
22. Goldman Sachs, Moodys, iCapital Investment Strategy, as of Nov. 13, 2023. Note: Default rate is the trailing 12-month issuer-weighted default rate.
23. Bloomberg, iCapital Investment Strategy, as of Dec. 13, 2023.
24. Bloomberg, FactSet, iCapital Investment Strategy, as of Dec. 13, 2023.
25. Bloomberg, iCapital Investment Strategy, as of Dec. 13, 2023.
26. Bloomberg, FactSet, iCapital Investment Strategy, as of Dec. 13, 2023.
27. Bloomberg, U.S. Treasury, iCapital Investment Strategy, as of Dec. 11, 2023.
28. Bloomberg, U.S. Treasury, iCapital Investment Strategy, as of Dec. 11, 2023. Note: maturing debt is based on marketable debt.
29. Congressional Budget Office, iCapital Investment Strategy, as of Sept. 18, 2023.
30. Treasury Borrowing Advisory Committee (TBAC), Apollo, iCapital Investment Strategy, as of Oct. 5, 2023.
31. Fitch, as of Aug. 1, 2023.
32. Bloomberg, U.S. Treasury, iCapital Investment Strategy, as of Dec. 4, 2023.
33. Mortgage Bankers Association, Goldman Sachs, iCapital Investment Strategy, as of Nov. 30, 2023.
34. S&P Global, Trepp, Goldman Sachs, as of Dec. 7, 2023. Note: CRE loan rates are proxied by conduit CMBS loans. The average rate is average coupon of new-issue conduit CMBS loans. Conduit CMBS loan data is as of Nov. 2023.
35. S&P Global, June 2, 2023. Note: this analysis is based on S&P Global-rated conduits with loans maturing 2023-2024.
36. Moodys, Pension Real Estate Association, as of Nov. 14, 2023. 37. CBRE, iCapital Investment Strategy, as of Oct. 30, 2023.
38. Trepp, iCapital Investment Strategy, as of Dec. 1, 2023.
39. CBRE, as of Aug. 1, 2023.
40. Nareit, CoStar, as of Feb. 15, 2022
41. JPMorgan, World Bank, Bureau of Economic Analysis, Bloomberg, Haver Analytics as of April 12, 2023.
42. SIFMA, Statista, iCapital Investment Strategy, as of Sept. 19, 2023. Note: MBS data is as of Dec. 31, 2021.
43. Pitchbook, iCapital Investment Strategy, as of Dec. 5, 2023. Note: Private Equity and Venture Capital deal volume is based on deal value and is annualized using year-to-date data through Sept. 30, 2023.
44. Pitchbook, as of July 25, 2023. Note: data as of Mar. 30, 2023.
45. iCapital Investment Strategy Analysis, as of Oct. 6, 2023. Note: Assuming we keep EBITDA constant, we can recalculate interest expense using today’s base rate of roughly 5.5%. When we do this, coverage ratios fall further to 1.7x.
46. iCapital Investment Strategy Analysis, as of Oct. 6, 2023.
47. S&P Global, as of Dec. 4, 2023. Note: Analysis includes S&P Global-covered U.S. companies that announced bankruptcy as of Nov. 30, 2023.
48. Pitchbook, LCD, as of Dec. 3, 2023. Note: data as of Nov. 30, 2023. The default rate does not include distressed debt exchanges which are more likely to preserve the equity stake held by private equity owners.
49. Preqin, iCapital Investment Strategy, as of Dec. 4, 2023.
50. Pitchbook, iCapital Investment Strategy, as of Dec. 4, 2023. Note: Venture Capital fundraising activity is based on capital raised and is annualized using year-to-date data through Sept. 30, 2023.
51. Preqin, iCapital Investment Strategy, as of Dec. 4, 2023. Note: To avoid double counting we exclude fund of funds and secondaries from the overall AUM.
52. Pitchbook, iCapital Investment Strategy, as of Dec. 4, 2023.
53. Stepstone, as of Dec. 31, 2021.
54. Pitchbook, iCapital Investment Strategy, as of Dec. 7, 2023. Note: Data as of Sept. 30, 2023.
55. Bloomberg, Pitchbook, iCapital Private Market Research, iCapital Investment Strategy, as of Dec. 7, 2023.
56. PitchBook, iCapital Investment Strategy, as of Dec. 7, 2023. Note: Data as of Sept. 30, 2023. PitchBook VC Dealmaking Indicator leverages deal-level data to quantify how startup-friendly, or investor-friendly the capital raising environment is. Higher Indicator values reflect a more investor-friendly dealmaking environment, and lower values a more startup-friendly one.
57. Bloomberg, iCapital Investment Strategy, as of Dec. 5, 2023. Note: Data as of November 30. 2023. Goldman Sachs Unprofitable Tech basket consists of non-profitable US listed companies in innovative industries.
58. Bloomberg, iCapital Investment Strategy, as of Dec. 5, 2023.
59. Bloomberg, iCapital Investment Strategy, as of Dec. 5, 2023.
60. Federal Reserve Bank of New York, Dec. 13, 2023.
61. Cliffwater, as of June 30, 2023.
62. Pitchbook, iCapital Investment Strategy, as of Dec. 7, 2023. Note: Data as of Sept. 30, 2023, and is subject to change based on potential updates to source(s) database. Median North America and Europe PE buyout EV/ EBITDA multiples.
63. Pitchbook, iCapital Investment Strategy, as of Dec. 7, 2023. Note: Data as of Sept. 30, 2023, and is subject to change based on potential updates to source(s) database.
64. Cliffwater, iCapital Investment Strategy, as of Dec. 7, 2023. Note: Data as of Sept. 30, 2023.
65. Mortgage Bankers Association, Chart of the Week, Mar. 10, 2023.
66. Bloomberg, iCapital Investment Strategy, as of Dec. 7, 2023. Note: SOFR + 400 bps is a rule of thumb which may not always hold true in reality.
67. Bloomberg, NCREIF, iCapital Investment Strategy, as of Dec. 7, 2023. Note: Data as of Sept. 30, 2023.
68. Bloomberg, iCapital Investment Strategy, as of Dec. 8, 2023. Note: Analysis is done on the last five rate-cutting cycles which include 1989, 1995, 2001, 2007, and 2019, and it is based on the Bloomberg Bond Municipal Index which measures the performance of the USD-denominated Long-Term tax- exempt bond market.
69. Bloomberg, iCapital Investment Strategy, as of Dec. 8, 2023.
70. Bloomberg, iCapital Investment Strategy, as of Dec. 8, 2023. Note: Tax-Equivalent Yield is based on a 40% effective tax rate.
71. Bloomberg, iCapital Investment Strategy, as of Dec. 8, 2023.
72. Envestment, iCapital Hedge Fund Research, iCapital Investment Strategy, as of Dec. 7, 2023.
73. Bloomberg, iCapital Investment Strategy, as of Dec. 7, 2023.
74. Bloomberg, HFRI, iCapital Investment Strategy, as of Dec. 7, 2023.
75. Bloomberg, HFRI, iCapital Investment Strategy, as of Dec. 7, 2023
76. Bloomberg, HFRI, iCapital Investment Strategy, as of Dec. 7, 2023.
77. iCapital, as of Dec. 13, 2023.
78. Life Insurance Marketing and Research Association (LIMRA), as of Oct. 25, 2023.
79. Life Insurance Marketing and Research Association (LIMRA), as of Oct. 25, 2023.
80. U.S. Census Bureau, as of Dec. 7, 2023.
81. Bloomberg, iCapital Investment Strategy, as of December 7, 2023.
82. iCapital, as of Dec. 7, 2023.
83. iCapital, as of Dec. 7, 2023.

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