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.
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