Five Questions: Catherine Keating on Investing in a Volatile Market

December 22, 2011  •  Carrie Coolidge

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With leadership changes likely to take place in a dozen countries in 2012, including the U.S. and China—which together represent half of global GDP—the impact on volatility in the capital markets could be significant. Catherine Keating, chief executive officer of United States institutional asset management at J.P. Morgan, which oversees more than $700 billion in client assets, recently spoke with Institutional Investor Contributor Carrie Coolidge about how investors can gird their portfolios and even capitalize on uncertainty.

1. Market turmoil is relentless. How can institutional investors lower volatility without sacrificing returns?

By reducing correlations. For example, real estate has a low correlation to equities and a negative correlation to bonds. Adding real estate to a traditional portfolio over the past 20 years would have both increased returns and decreased volatility. Having income as a portion of total return is also a buffer to volatility. Historically, dividends have accounted for roughly 40 percent of S&P 500 returns. With corporate balance sheets healthy and often cash-heavy today, dividends can be an important component of return on stocks around the world. Then there’s managing or minimizing beta [market risk]. Over the past 15 years, a well-­constructed portfolio of diversified hedge funds has achieved high-single-digit returns with mid-single-digit volatility. If you minimize volatility, you can maximize compounding in your portfolio.

2. What are the best alternative investments right now?

The extended credit markets, such as bank loans and mezzanine debt, are good alternatives. We expect that interest rates will stay low for an extended period, so investors will be looking to augment bond yields. The developed world is in the middle of a deleveraging cycle. An institutional investor with capital and patience can earn attractive returns as a lender. We also like global private equity. Emerging economies are growing quickly, yet public markets in emerging economies are often immature and concentrated in a few companies or sectors. 

3. What types of investments do you recommend for protecting against inflation?

Over the last 20 years, every 1 percent increase in the [Consumer Price Index] has been associated with a 10 percent increase in commodity prices. So a relatively small addition of commodities can hedge a lot of inflation risk in a portfolio.

4. Is there a role for active management in a portfolio today?

Yes. Active management adds value, particularly in less-efficient asset classes and in more-mature phases of a business cycle. Markets tend to have periods of synchronization—for example, a crisis and initial recovery. Then there are periods of differentiation, where trends begin to diverge and active management based on company fundamentals can thrive. 

5. What do you think about demographics?

There are two sides to this issue: young, high-growth emerging economies and more-mature, slower-growth developed economies. Investors need to address both. They need the perspective and the skill to capture global growth, yet at the same time they have to manage the implications of having declining and aging populations in much of the developed world. There are many ways investors can access global growth, starting with U.S. large-cap equities, because 30 percent of S&P revenues are produced outside the U.S.