Assessing the Vulnerabilities in Portfolios—and What to Do About Them
Head of Client Service and Editor of Bridgewater's Daily Observations, Jim Haskel, recently sat down with WTW’s Jon Pliner and Mercer’s Rich Nuzum to discuss the risks they see in asset allocations today and how investors can help protect their portfolios. The conversation focuses on the main vulnerabilities in portfolios today and how improved governance and diversification can help address them.
Recorded Date: June 30, 2025
Editor’s note: The views of external guests do not necessarily reflect the views of Bridgewater
TRANSCRIPT
Chapter 1: The Vulnerabilities in Portfolios
Jim Haskel
Rich and Jon, it is such a treat to have you guys here at Bridgewater, on our campus, to talk about some of the issues we’ve been talking about with our clients. One of the reasons that I wanted to have both of you in is, first of all, you advise on trillions of dollars’ worth of assets across the world, multiple types of entities, from sovereign wealth funds to family offices and everything in between. And therefore, you see what’s happening in global portfolios, you see where the vulnerabilities are, and hopefully can have big impact in terms of how to steer portfolios in the right direction—not for the past, but for the future.
With that said, I want to share with you some of the things that we’ve been pretty vocal on, which is that today, when we look at portfolios, we both understand why big institutional pools of capital are positioned the way they are, which is very, very concentrated in equity risk, very concentrated in US equity risk and the US dollar, and much less exposure to diversifying return streams, and also materially more illiquid exposure than what we saw prior to, let’s say, 2010. And by and large, all that’s worked out over the last 15 years. So, we find ourselves in a very interesting position. And I haven’t even gotten to the pricing of the main asset that people have, which is US equities.
That’s how we’re seeing it. And what we’re saying to clients is we really believe there’s a material need for you to pay attention to these issues right now and be intentional about whether you want to continue with that kind of exposure or whether now it’s time to diversify. That is what Bridgewater has been saying.
I want to turn to both of you and have you synthesize how you’re viewing the global picture and what you think is most important. And I’ll start with you, Jon.
Jon Pliner
Sure. Thanks, Jim. I think to start, let’s recognize that part of the reason we’re in the situation we are today is because it has worked for the last 10 to 15 years. And what that means is it can be hard for asset owners to take a look back and say, “Let’s do something different.”
But from our perspective, there are more risks in the world today, more differentiated risks than perhaps we’ve seen over the last 15 years. You had zero interest rates, you had very low inflation, you didn’t necessarily see a world where that spiked. Today, we have two sides of that risk. You could see increased inflation—stickier inflation—or you could see recession. And so, from that standpoint alone, taking a step back, looking at the portfolio, making sure that you are comfortable with where you sit going forward and that you’re comfortable with the risks that you hold—in particular, the concentration risk in US assets—is key for asset owners from here.
Jim Haskel
And just before I turn to Rich, is this business as usual or is this more front of mind as you’re sitting there with your client relationships about what you think they ought to be focused on?
Jon Pliner
This is certainly front of mind, particularly given we just had a recent bout of quite a bit of volatility, which opened eyes. And so I think there is an impetus now to take that step back and really look, going forward, are we going to be in a different environment, and are we comfortable with the way that our portfolios sit from here?
Jim Haskel
Rich, let me turn to you. Jon talked about the fact that, yes, he sees vulnerabilities and it’s front of mind. Let me just ask you, do you see those same vulnerabilities, and is it front of mind or business as usual?
Rich Nuzum
I see those vulnerabilities in spades, and it’s front of mind. And I’ll divide asset owners into two camps. US home-country investors, US dollar-denominated investors tend to be massively overweight the US against global market capitalization because that’s worked well. And if they moved away from that, they underperformed their peer group, and so the governance dynamics were such that they moved back to being overweight. Non-US investors have been beat up if they were underweight the US.
And so I try to take a blank-sheet-of-paper approach when I’m meeting with an asset owner, but I kind of expect to see not just the US stock market but the US dollar overweight and unhedged, the US economy, the US stock market, yes, but also in their private market allocations, particularly private equity, real estate, private credit, to see a massive overweight to the US compared to its GDP weight or even its market-cap weight in public markets, because that’s where the strong IRRs have been. Investors looking for private market allocations have come to the US because that’s where the success has been. And so they’re even more overweight there than they are in the public markets.
Chapter 2: The New Environment and Current Pricing Are a Challenge to Most Portfolios
Jim Haskel
Now, at Bridgewater, we’ve been articulating two big things. One is that we’re operating in a new paradigm. We’re calling it “modern mercantilism,” which is distinctly different from, let’s say, the global-free-market-capitalism type of system that we’ve been in. There are many points of difference. Trade is like a zero-sum game now as opposed to a win-win game. National strength is important. Controlling supply lines is important because geopolitical conflict is much more acute today. So there’s a difference in the paradigms, which are not as supportive of most assets as previously. That’s number one.
Number two is the pricing is completely different. If you go back to 2010, US equities on a valuation basis, by historical standards, were relatively cheap because we just had the sell-off from the global financial crisis, the dollar was attractive, and you had all this supportive monetary and fiscal policy, which was starting to add up to an attractive tailwind. You also had viable tech companies—we were still leaders in tech—and so on. So all these things were going on. Geopolitical conflict was not nearly as acute as it is today.
Those were the tailwinds. And yet today, many of those things are flipped. So, US valuations on an absolute basis are at the higher end of their historical valuations, and on a relative basis to other markets—Japan or Europe—are very, very stretched relative to normal. That’s another reason why the change in paradigm and the change in pricing have led us to being quite vocal.
I want to see if you both see it the same way or differently. And feel free to totally disagree and tell us we’re completely wrong, which is the change in paradigm and the change in pricing. Let me start with you, Rich.
Rich Nuzum
I think it’s even worse than you characterized because it’s not just the public markets priced for perfection and trading at high valuations. In the private markets, private credit spreads have come in, instruments that used to get 5% yield premium against comparable investment-grade public, you’re getting 3% or 2.5%. If it was 3%, it’s now 1%. And that’s causing smart CIOs to think, “I don’t know what’s going to trigger the next crisis, but we’re a day closer to it than we were yesterday, and it’s going to happen at some point.”
So, a lot of examination of portfolios to, “Are we really well-diversified, and is our governance ready for the next crisis?” Because the global economic flywheel has been moving pretty well. Other than China, we’ve had full employment with inflation coming under control. We’ve even powered through the uncertainty shock, the wait-and-see shock of the “Liberation Day” announcements and all the trade and tariff discussions over the last few months. We’ve powered through that. And as we started the conversation today, we’re up 5.5% as a dollar-denominated investor in US equities year-to-date. That’s an amazing accomplishment—lots of strength there, lots of optimism. But when I talk to smart CIOs, they think, “Too much optimism. We need to be ready.”
Jim Haskel
And that’s the paradigm. Do you see a paradigm change?
Rich Nuzum
Well, the big paradigm change that’s causing panic among CIOs is that the US dollar and US Treasuries have not behaved as safe-haven assets year-to-date. We’ve got, as Jon mentioned earlier, the market volatility. The VIX spiked to 50, our one-month gauge of forward-looking volatility that you can bet on.
So, smart people were saying, “We think on average the market’s going to be 50% volatile now as opposed to 15% pre-these announcements. OK, we didn’t see that level of market volatility previously.” You have to go back to March 2020, the depths of COVID, when the real world looked like it might actually be coming to an end—or October 2008, when it looked like both the financial world and the real world were coming to an end. We had the US auto sector bankrupt. We had entire states in fiscal deficit, mass unemployment, and didn’t know that we were going to come back. So, really high market volatility.
Historically, when we had that kind of shock, the dollar did well and Treasuries did well, and suddenly they didn’t. And that just causes all the asset allocation risk-budgeting math that people have been relying on, that just gets thrown out the window, and we need a new paradigm.
Jon Pliner
So, from our perspective, yes, it is somewhat of a new paradigm, but the US, while valuations are quite high relative to elsewhere, still does have a lot of technological innovation that’s happening here that is strong. When we think about the concentration in markets, and using equities as the example, given the growth that you’ve seen in the US market over the last 15 years, I think it’s just making sure we take a step back and that we’re getting the right diversification.
If we are in a world where you do see individual countries, or blocs, at least, kind of moving within and trying to recreate supply lines, onshore as opposed to offshore, having more exposure to different parts of the world and different economies or different blocs will be helpful.
You also have a shift from Europe, if you think about the way that Germany, for example, has adjusted their budget to spend more, to move away from austerity. And so, while those assets are quite cheap on a valuation basis, you have some tailwinds behind as well for why those should do well. But, at the same time, a lot of that innovation is still coming from US-domiciled companies. So it’s not a “sell the US” so much as it is make sure we have the right diversification, and you’re getting that exposure at a level that’s going to support your portfolio.
Chapter 3: Is Now the Time to Reallocate?
Jim Haskel
Let me dig a little bit deeper into this. And, Jon, I’m going to start with you. When I look at not only the state of portfolios but the pricing of those portfolios, what I see is US equity valuations around all-time highs. So, on an absolute level, the threshold for repeating the same kind of performance that we had before, over the last 15 years, the probability of that is quite low, just statistically. And then I see a different paradigm, which we talked about. But in that, I also see foreign valuations—so, around the world, much more competitive than what I see in the US.
Let me just talk about what that implies. Is now the time to move exposures from the US to foreign markets— whether that be Japan or Europe or what have you, just more diversified—simply because the pricing is so extreme between US valuations and foreign valuations?
Jon Pliner
It’s a great question. I don’t think that it’s necessarily that because of the extremities of those valuation differentials, we should automatically be overweighting Europe relative to a market-cap benchmark or overweighting Japan.
That being said, we do think there are opportunities, but there are also reasons why we’re in the position we are today. Particularly relative to Europe, you’ve seen a lot more of the technological innovation coming from the US, and that still is absent within the European markets. And so, there is some reason for why valuations are so differentiated.
But we have seen, with the removal of some of the austerity starting to come through in Europe, that perhaps there is opportunity to see a bit more growth coming out of those markets and a bit more attractiveness, not purely based on valuations—take Germany, for example, with the spending that they plan to do in the budget on both infrastructure as well as defense. But seeing that shift in mindset from one of pure austerity to one somewhat more pro-growth, I think will be helpful for markets. And so, we do think that there are some attractive opportunities there.
Similarly, in Japan, we do think that there continues to be opportunity in the Japanese market.
And so, looking at perhaps shifting some of that US, I call it “overweight” to other markets, I think it is an appropriate step to be considering.
Jim Haskel
Rich?
Rich Nuzum
I think it’s never too early or the wrong time to diversify. And asset owners, particularly when there are lay trustees involved, so non-investment experts, they often focus on the top level. So, the US has stronger GDP growth than the rest of the G7, better demographics than most of the rest of the G7, a lot of the thesis of US exceptionalism is still alive, and we have the Magnificent Seven all headquartered here—that’s a lot of good things. But then on a valuation standpoint, if the price/earnings ratio on US stocks is twice what it is in Europe and Japan, which is about where it’s been, that means that those US companies have to deliver twice their earnings growth to justify the valuation differential.
And so, looking at valuations can help asset owners adjust quickly for “OK, so we understand Europe’s overregulated and has worse demographics. We understand Japan and China are competing for who has the worst demographics on the planet. And yet, if we’re getting the same earnings yield at half the cost, maybe we should have some of our portfolio there.” So, it’s an issue of balance.
Then, if the growth comes through, again, it depends on the client’s investment objectives. There’s a big difference between a client who’s peer-group-median benchmarked, and so can’t be very different from their competitors, and an asset owner who really wants to pursue an economic objective, where if they’re more diversified than other funds, as long as they’re hitting their investment objective, it doesn’t matter if others have done better. But really understanding, are you peer-group-median benchmarked and you’re going to get compared after the fact to the group? Or are you really able to pursue your economic objective? I think that’s an important prerequisite to then either letting the math drive the diversification or being very careful about making big bets against what your competitors are doing.
Jim Haskel
So, I read both of you as saying, given the starting concentration of these portfolios in US equities, that from a pure investment perspective, it would pay to diversify, just because, even if you were wrong, you already have such a concentrated bet in US equities. However, there are real governance issues to work through. And those governance issues can basically, if you’re going to take that benchmark risk, then you need to be able to have your stakeholders bought in. Is that basically what I hear from you?
Jon Pliner
Yes, that’s a fair representation.
Rich Nuzum
Yes, and bought into where, after the fact, and you can try to help them pre-experience this, if they look at their performance report and they’re getting cash-plus-5% or inflation-plus-4%, they’re happy even if their competitors are getting 16% nominal in that particular year or three-year period. So, are they going to be happy in that or not? Because if they’re not, if their revealed risk tolerance is different, if their revealed objective is different after the fact, the portfolio can get whipsawed, which is not a good way to invest.
Jon Pliner
Things like pre-mortems can help with that with multiple stakeholders.
Jim Haskel
Explain pre-mortems.
Jon Pliner
So, thinking about what could go wrong: How could this go wrong? How could this go against you?
To Rich’s example of a stakeholder who you think that perhaps is more economic-sensitive from a benchmark standpoint, but after the fact, you’ve underperformed the peer group and that’s where issues arise—have a look at that ahead of time, show what those numbers could look like, and have the discussion of where did this go wrong? Why did it go wrong? Are we comfortable with it?
Jim Haskel
On this question of geographic diversification, we’ve even written some pieces—we’ve talked about Asia, we’ve talked about even in AI on how you could get diversification outside the US, and it’s mostly on the diversification piece.
And my question to you is, taking diversification aside, do you see any good return possibilities? You mentioned Europe and the fiscal situation in Europe starting to present a potential tailwind there. And in Japan, we’ve seen a little bit of a tailwind as well. But are there any particular markets where you’d say, not only is it good to diversify, I actually think this is going to be a really good story, and you’re advising clients as such?
Let me start with you, Rich.
Rich Nuzum
The short answer is yes. And I’ll take it even further. You mentioned developed market regions—Western Europe, Japan—but we’re bullish about the emerging and frontier market economies on a long-term basis. That doesn’t necessarily mean overweighting emerging- and frontier-market-domiciled stocks. The Magnificent Seven produce and sell globally; those are global multinationals, not just US companies. So, when you invest in publicly traded stocks, you need to look at what’s the underlying source of revenue and NOI.
But 70-80% of the world’s population is in the emerging and frontier markets. If you look back the last 10 years at global GDP growth, about 60-70% of global GDP growth is happening in those markets, and many of them are coming from low income to middle income, which is a pretty well-trodden place to go. They’re benefiting hugely from getting labor pulled into the global workforce—without having to physically emigrate—by the evolution of digital and AI technologies, particularly the ability to translate to and from English and any local language for labor that didn’t have English as a second language and otherwise wouldn’t be able to participate in a global economy.
So, there’s a lot of bullishness there, and that’s part of what’s driving the interest in infrastructure as an asset class. We recently did our annual “Large Asset Owner Barometer” survey, and the two asset classes where asset owners above $2 billion told us they’re going to put the most new money are infrastructure and private credit. And when we dig below the headline—“Well, what are you looking for there?”—with infrastructure, it’s exposure to the local economy and local GDP growth, because infrastructure investments tend to be inherently “local, local,” and then for private credit, it’s through asset-based finance, through regulatory arbitrage, other areas where it’s not correlated to the broad economy, it’s not even correlated to broader credit, and so you’re getting some real diversification that you can’t get in the public markets.
Now with those two asset classes, you take on more illiquidity risk. And liquidity hasn’t been there in private equity or real estate or infrastructure or private credit in the way that a lot of asset owners expected. So, you’re kind of doubling down on an area where there’s already been a disappointment in terms of the amount of real liquidity, money coming back. But the diversification potential, that’s what’s driving some of that, including getting beyond the developed markets into the emerging and frontier.
Jon Pliner
I think I’d agree with everything that Rich just said. I think the other thing I’d add on is what you’re also moving beyond is corporate profits and what’s driving the cash flows and the return generation. And I think from not just a diversification standpoint but also a return-generation standpoint, moving beyond just making money off of corporate profits, whether that’s through corporate debt or through equities, I think is a key to developing those long-term diversifying return streams that actually are return streams.
I think the flip side from a return-generation standpoint is also the protection side. And we’ve been in an environment where Treasuries have been a key form of downside hedging for a lot of portfolios for some time. And I think we’re entering a period where diversifying that is perhaps something we’ve seen a lot more interest in and have had a lot more discussions and movement on—not even getting to the point of moving beyond interest rates as a downside hedge but even just where your interest rates are coming from, moving that to more than just the US but to other sovereigns as well.
Rich Nuzum
If I can amplify on Jon’s point, when I meet with CIOs of really large investors, $100-billion-plus investors, and ask them what are they most worried about or most shocked by, the concept of regime change comes up, and what they seem to be most worried about and kind of emotionally almost disturbed about is the US Treasuries and US dollar have not behaved as safe-haven assets year-to-date. That doesn’t just cause their portfolio to perform differently than expected; it blows the whole math of their diversification model, of their asset-allocation model, out of the water. It’s been in the data that when the world hits a crisis, US Treasuries do well, the US dollar does well, and suddenly they don’t. And so what do you do with your portfolio when that’s one of the bedrocks of what you were doing?
Another example of regime change is when stagflation in the US is the issue. And to the extent we have relatively bullish versus bearish projections around tariff policy, that’s a potential stagflationary shock. So that’s been driving things. Well, then stock/bond correlations spike, and they’ve been running at about 80% year-to-date. So, again, that breaks down diversification in your portfolio. Now, that’s relatively more understood, that in a stagflation environment that’s going to happen, so it’s not as shocking to people, it doesn’t produce the same emotional reaction, but it does give a sense of, “OK, we’re in a different regime, but actually we’re in one past that that we’ve never actually modeled or played with because the safe-haven assets—the US dollar, US Treasuries—are suddenly not behaving as safe-haven assets.”
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Recorded Date: June 30, 2025
Editor’s note: The views of external guests do not necessarily reflect the views of Bridgewater
TRANSCRIPT
Chapter 1: The Vulnerabilities in Portfolios
Jim Haskel
Rich and Jon, it is such a treat to have you guys here at Bridgewater, on our campus, to talk about some of the issues we’ve been talking about with our clients. One of the reasons that I wanted to have both of you in is, first of all, you advise on trillions of dollars’ worth of assets across the world, multiple types of entities, from sovereign wealth funds to family offices and everything in between. And therefore, you see what’s happening in global portfolios, you see where the vulnerabilities are, and hopefully can have big impact in terms of how to steer portfolios in the right direction—not for the past, but for the future.
With that said, I want to share with you some of the things that we’ve been pretty vocal on, which is that today, when we look at portfolios, we both understand why big institutional pools of capital are positioned the way they are, which is very, very concentrated in equity risk, very concentrated in US equity risk and the US dollar, and much less exposure to diversifying return streams, and also materially more illiquid exposure than what we saw prior to, let’s say, 2010. And by and large, all that’s worked out over the last 15 years. So, we find ourselves in a very interesting position. And I haven’t even gotten to the pricing of the main asset that people have, which is US equities.
That’s how we’re seeing it. And what we’re saying to clients is we really believe there’s a material need for you to pay attention to these issues right now and be intentional about whether you want to continue with that kind of exposure or whether now it’s time to diversify. That is what Bridgewater has been saying.
I want to turn to both of you and have you synthesize how you’re viewing the global picture and what you think is most important. And I’ll start with you, Jon.
Jon Pliner
Sure. Thanks, Jim. I think to start, let’s recognize that part of the reason we’re in the situation we are today is because it has worked for the last 10 to 15 years. And what that means is it can be hard for asset owners to take a look back and say, “Let’s do something different.”
But from our perspective, there are more risks in the world today, more differentiated risks than perhaps we’ve seen over the last 15 years. You had zero interest rates, you had very low inflation, you didn’t necessarily see a world where that spiked. Today, we have two sides of that risk. You could see increased inflation—stickier inflation—or you could see recession. And so, from that standpoint alone, taking a step back, looking at the portfolio, making sure that you are comfortable with where you sit going forward and that you’re comfortable with the risks that you hold—in particular, the concentration risk in US assets—is key for asset owners from here.
Jim Haskel
And just before I turn to Rich, is this business as usual or is this more front of mind as you’re sitting there with your client relationships about what you think they ought to be focused on?
Jon Pliner
This is certainly front of mind, particularly given we just had a recent bout of quite a bit of volatility, which opened eyes. And so I think there is an impetus now to take that step back and really look, going forward, are we going to be in a different environment, and are we comfortable with the way that our portfolios sit from here?
Jim Haskel
Rich, let me turn to you. Jon talked about the fact that, yes, he sees vulnerabilities and it’s front of mind. Let me just ask you, do you see those same vulnerabilities, and is it front of mind or business as usual?
Rich Nuzum
I see those vulnerabilities in spades, and it’s front of mind. And I’ll divide asset owners into two camps. US home-country investors, US dollar-denominated investors tend to be massively overweight the US against global market capitalization because that’s worked well. And if they moved away from that, they underperformed their peer group, and so the governance dynamics were such that they moved back to being overweight. Non-US investors have been beat up if they were underweight the US.
And so I try to take a blank-sheet-of-paper approach when I’m meeting with an asset owner, but I kind of expect to see not just the US stock market but the US dollar overweight and unhedged, the US economy, the US stock market, yes, but also in their private market allocations, particularly private equity, real estate, private credit, to see a massive overweight to the US compared to its GDP weight or even its market-cap weight in public markets, because that’s where the strong IRRs have been. Investors looking for private market allocations have come to the US because that’s where the success has been. And so they’re even more overweight there than they are in the public markets.
Chapter 2: The New Environment and Current Pricing Are a Challenge to Most Portfolios
Jim Haskel
Now, at Bridgewater, we’ve been articulating two big things. One is that we’re operating in a new paradigm. We’re calling it “modern mercantilism,” which is distinctly different from, let’s say, the global-free-market-capitalism type of system that we’ve been in. There are many points of difference. Trade is like a zero-sum game now as opposed to a win-win game. National strength is important. Controlling supply lines is important because geopolitical conflict is much more acute today. So there’s a difference in the paradigms, which are not as supportive of most assets as previously. That’s number one.
Number two is the pricing is completely different. If you go back to 2010, US equities on a valuation basis, by historical standards, were relatively cheap because we just had the sell-off from the global financial crisis, the dollar was attractive, and you had all this supportive monetary and fiscal policy, which was starting to add up to an attractive tailwind. You also had viable tech companies—we were still leaders in tech—and so on. So all these things were going on. Geopolitical conflict was not nearly as acute as it is today.
Those were the tailwinds. And yet today, many of those things are flipped. So, US valuations on an absolute basis are at the higher end of their historical valuations, and on a relative basis to other markets—Japan or Europe—are very, very stretched relative to normal. That’s another reason why the change in paradigm and the change in pricing have led us to being quite vocal.
I want to see if you both see it the same way or differently. And feel free to totally disagree and tell us we’re completely wrong, which is the change in paradigm and the change in pricing. Let me start with you, Rich.
Rich Nuzum
I think it’s even worse than you characterized because it’s not just the public markets priced for perfection and trading at high valuations. In the private markets, private credit spreads have come in, instruments that used to get 5% yield premium against comparable investment-grade public, you’re getting 3% or 2.5%. If it was 3%, it’s now 1%. And that’s causing smart CIOs to think, “I don’t know what’s going to trigger the next crisis, but we’re a day closer to it than we were yesterday, and it’s going to happen at some point.”
So, a lot of examination of portfolios to, “Are we really well-diversified, and is our governance ready for the next crisis?” Because the global economic flywheel has been moving pretty well. Other than China, we’ve had full employment with inflation coming under control. We’ve even powered through the uncertainty shock, the wait-and-see shock of the “Liberation Day” announcements and all the trade and tariff discussions over the last few months. We’ve powered through that. And as we started the conversation today, we’re up 5.5% as a dollar-denominated investor in US equities year-to-date. That’s an amazing accomplishment—lots of strength there, lots of optimism. But when I talk to smart CIOs, they think, “Too much optimism. We need to be ready.”
Jim Haskel
And that’s the paradigm. Do you see a paradigm change?
Rich Nuzum
Well, the big paradigm change that’s causing panic among CIOs is that the US dollar and US Treasuries have not behaved as safe-haven assets year-to-date. We’ve got, as Jon mentioned earlier, the market volatility. The VIX spiked to 50, our one-month gauge of forward-looking volatility that you can bet on.
So, smart people were saying, “We think on average the market’s going to be 50% volatile now as opposed to 15% pre-these announcements. OK, we didn’t see that level of market volatility previously.” You have to go back to March 2020, the depths of COVID, when the real world looked like it might actually be coming to an end—or October 2008, when it looked like both the financial world and the real world were coming to an end. We had the US auto sector bankrupt. We had entire states in fiscal deficit, mass unemployment, and didn’t know that we were going to come back. So, really high market volatility.
Historically, when we had that kind of shock, the dollar did well and Treasuries did well, and suddenly they didn’t. And that just causes all the asset allocation risk-budgeting math that people have been relying on, that just gets thrown out the window, and we need a new paradigm.
Jon Pliner
So, from our perspective, yes, it is somewhat of a new paradigm, but the US, while valuations are quite high relative to elsewhere, still does have a lot of technological innovation that’s happening here that is strong. When we think about the concentration in markets, and using equities as the example, given the growth that you’ve seen in the US market over the last 15 years, I think it’s just making sure we take a step back and that we’re getting the right diversification.
If we are in a world where you do see individual countries, or blocs, at least, kind of moving within and trying to recreate supply lines, onshore as opposed to offshore, having more exposure to different parts of the world and different economies or different blocs will be helpful.
You also have a shift from Europe, if you think about the way that Germany, for example, has adjusted their budget to spend more, to move away from austerity. And so, while those assets are quite cheap on a valuation basis, you have some tailwinds behind as well for why those should do well. But, at the same time, a lot of that innovation is still coming from US-domiciled companies. So it’s not a “sell the US” so much as it is make sure we have the right diversification, and you’re getting that exposure at a level that’s going to support your portfolio.
Chapter 3: Is Now the Time to Reallocate?
Jim Haskel
Let me dig a little bit deeper into this. And, Jon, I’m going to start with you. When I look at not only the state of portfolios but the pricing of those portfolios, what I see is US equity valuations around all-time highs. So, on an absolute level, the threshold for repeating the same kind of performance that we had before, over the last 15 years, the probability of that is quite low, just statistically. And then I see a different paradigm, which we talked about. But in that, I also see foreign valuations—so, around the world, much more competitive than what I see in the US.
Let me just talk about what that implies. Is now the time to move exposures from the US to foreign markets— whether that be Japan or Europe or what have you, just more diversified—simply because the pricing is so extreme between US valuations and foreign valuations?
Jon Pliner
It’s a great question. I don’t think that it’s necessarily that because of the extremities of those valuation differentials, we should automatically be overweighting Europe relative to a market-cap benchmark or overweighting Japan.
That being said, we do think there are opportunities, but there are also reasons why we’re in the position we are today. Particularly relative to Europe, you’ve seen a lot more of the technological innovation coming from the US, and that still is absent within the European markets. And so, there is some reason for why valuations are so differentiated.
But we have seen, with the removal of some of the austerity starting to come through in Europe, that perhaps there is opportunity to see a bit more growth coming out of those markets and a bit more attractiveness, not purely based on valuations—take Germany, for example, with the spending that they plan to do in the budget on both infrastructure as well as defense. But seeing that shift in mindset from one of pure austerity to one somewhat more pro-growth, I think will be helpful for markets. And so, we do think that there are some attractive opportunities there.
Similarly, in Japan, we do think that there continues to be opportunity in the Japanese market.
And so, looking at perhaps shifting some of that US, I call it “overweight” to other markets, I think it is an appropriate step to be considering.
Jim Haskel
Rich?
Rich Nuzum
I think it’s never too early or the wrong time to diversify. And asset owners, particularly when there are lay trustees involved, so non-investment experts, they often focus on the top level. So, the US has stronger GDP growth than the rest of the G7, better demographics than most of the rest of the G7, a lot of the thesis of US exceptionalism is still alive, and we have the Magnificent Seven all headquartered here—that’s a lot of good things. But then on a valuation standpoint, if the price/earnings ratio on US stocks is twice what it is in Europe and Japan, which is about where it’s been, that means that those US companies have to deliver twice their earnings growth to justify the valuation differential.
And so, looking at valuations can help asset owners adjust quickly for “OK, so we understand Europe’s overregulated and has worse demographics. We understand Japan and China are competing for who has the worst demographics on the planet. And yet, if we’re getting the same earnings yield at half the cost, maybe we should have some of our portfolio there.” So, it’s an issue of balance.
Then, if the growth comes through, again, it depends on the client’s investment objectives. There’s a big difference between a client who’s peer-group-median benchmarked, and so can’t be very different from their competitors, and an asset owner who really wants to pursue an economic objective, where if they’re more diversified than other funds, as long as they’re hitting their investment objective, it doesn’t matter if others have done better. But really understanding, are you peer-group-median benchmarked and you’re going to get compared after the fact to the group? Or are you really able to pursue your economic objective? I think that’s an important prerequisite to then either letting the math drive the diversification or being very careful about making big bets against what your competitors are doing.
Jim Haskel
So, I read both of you as saying, given the starting concentration of these portfolios in US equities, that from a pure investment perspective, it would pay to diversify, just because, even if you were wrong, you already have such a concentrated bet in US equities. However, there are real governance issues to work through. And those governance issues can basically, if you’re going to take that benchmark risk, then you need to be able to have your stakeholders bought in. Is that basically what I hear from you?
Jon Pliner
Yes, that’s a fair representation.
Rich Nuzum
Yes, and bought into where, after the fact, and you can try to help them pre-experience this, if they look at their performance report and they’re getting cash-plus-5% or inflation-plus-4%, they’re happy even if their competitors are getting 16% nominal in that particular year or three-year period. So, are they going to be happy in that or not? Because if they’re not, if their revealed risk tolerance is different, if their revealed objective is different after the fact, the portfolio can get whipsawed, which is not a good way to invest.
Jon Pliner
Things like pre-mortems can help with that with multiple stakeholders.
Jim Haskel
Explain pre-mortems.
Jon Pliner
So, thinking about what could go wrong: How could this go wrong? How could this go against you?
To Rich’s example of a stakeholder who you think that perhaps is more economic-sensitive from a benchmark standpoint, but after the fact, you’ve underperformed the peer group and that’s where issues arise—have a look at that ahead of time, show what those numbers could look like, and have the discussion of where did this go wrong? Why did it go wrong? Are we comfortable with it?
Jim Haskel
On this question of geographic diversification, we’ve even written some pieces—we’ve talked about Asia, we’ve talked about even in AI on how you could get diversification outside the US, and it’s mostly on the diversification piece.
And my question to you is, taking diversification aside, do you see any good return possibilities? You mentioned Europe and the fiscal situation in Europe starting to present a potential tailwind there. And in Japan, we’ve seen a little bit of a tailwind as well. But are there any particular markets where you’d say, not only is it good to diversify, I actually think this is going to be a really good story, and you’re advising clients as such?
Let me start with you, Rich.
Rich Nuzum
The short answer is yes. And I’ll take it even further. You mentioned developed market regions—Western Europe, Japan—but we’re bullish about the emerging and frontier market economies on a long-term basis. That doesn’t necessarily mean overweighting emerging- and frontier-market-domiciled stocks. The Magnificent Seven produce and sell globally; those are global multinationals, not just US companies. So, when you invest in publicly traded stocks, you need to look at what’s the underlying source of revenue and NOI.
But 70-80% of the world’s population is in the emerging and frontier markets. If you look back the last 10 years at global GDP growth, about 60-70% of global GDP growth is happening in those markets, and many of them are coming from low income to middle income, which is a pretty well-trodden place to go. They’re benefiting hugely from getting labor pulled into the global workforce—without having to physically emigrate—by the evolution of digital and AI technologies, particularly the ability to translate to and from English and any local language for labor that didn’t have English as a second language and otherwise wouldn’t be able to participate in a global economy.
So, there’s a lot of bullishness there, and that’s part of what’s driving the interest in infrastructure as an asset class. We recently did our annual “Large Asset Owner Barometer” survey, and the two asset classes where asset owners above $2 billion told us they’re going to put the most new money are infrastructure and private credit. And when we dig below the headline—“Well, what are you looking for there?”—with infrastructure, it’s exposure to the local economy and local GDP growth, because infrastructure investments tend to be inherently “local, local,” and then for private credit, it’s through asset-based finance, through regulatory arbitrage, other areas where it’s not correlated to the broad economy, it’s not even correlated to broader credit, and so you’re getting some real diversification that you can’t get in the public markets.
Now with those two asset classes, you take on more illiquidity risk. And liquidity hasn’t been there in private equity or real estate or infrastructure or private credit in the way that a lot of asset owners expected. So, you’re kind of doubling down on an area where there’s already been a disappointment in terms of the amount of real liquidity, money coming back. But the diversification potential, that’s what’s driving some of that, including getting beyond the developed markets into the emerging and frontier.
Jon Pliner
I think I’d agree with everything that Rich just said. I think the other thing I’d add on is what you’re also moving beyond is corporate profits and what’s driving the cash flows and the return generation. And I think from not just a diversification standpoint but also a return-generation standpoint, moving beyond just making money off of corporate profits, whether that’s through corporate debt or through equities, I think is a key to developing those long-term diversifying return streams that actually are return streams.
I think the flip side from a return-generation standpoint is also the protection side. And we’ve been in an environment where Treasuries have been a key form of downside hedging for a lot of portfolios for some time. And I think we’re entering a period where diversifying that is perhaps something we’ve seen a lot more interest in and have had a lot more discussions and movement on—not even getting to the point of moving beyond interest rates as a downside hedge but even just where your interest rates are coming from, moving that to more than just the US but to other sovereigns as well.
Rich Nuzum
If I can amplify on Jon’s point, when I meet with CIOs of really large investors, $100-billion-plus investors, and ask them what are they most worried about or most shocked by, the concept of regime change comes up, and what they seem to be most worried about and kind of emotionally almost disturbed about is the US Treasuries and US dollar have not behaved as safe-haven assets year-to-date. That doesn’t just cause their portfolio to perform differently than expected; it blows the whole math of their diversification model, of their asset-allocation model, out of the water. It’s been in the data that when the world hits a crisis, US Treasuries do well, the US dollar does well, and suddenly they don’t. And so what do you do with your portfolio when that’s one of the bedrocks of what you were doing?
Another example of regime change is when stagflation in the US is the issue. And to the extent we have relatively bullish versus bearish projections around tariff policy, that’s a potential stagflationary shock. So that’s been driving things. Well, then stock/bond correlations spike, and they’ve been running at about 80% year-to-date. So, again, that breaks down diversification in your portfolio. Now, that’s relatively more understood, that in a stagflation environment that’s going to happen, so it’s not as shocking to people, it doesn’t produce the same emotional reaction, but it does give a sense of, “OK, we’re in a different regime, but actually we’re in one past that that we’ve never actually modeled or played with because the safe-haven assets—the US dollar, US Treasuries—are suddenly not behaving as safe-haven assets.”
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