Viewpoint’s Keith McLean: investing during stubborn inflation

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Keith McLean, Toronto-based executive vice-president at Viewpoint Investment Partners, cautions investors that the firm anticipates inflation may stay higher for longer than expected.

From his work with Overbay Capital Partners private secondaries firm, to Fortitude Circle blockchain analysis firm and Cabrasuke Inc. family holding company, he has been analyzing markets and offering portfolio management advice for more than 20 years.

Calgary-based Viewpoint, which manages money for select families, grew out of the family wealth management vehicle of Mac Van Wielingen, a founder at ARC Resources Ltd. and ARC Financial Corp.

In a recent conversation with Canadian Family Offices, McLean offered Viewpoint’s take on current economic conditions and outlook, and the firm’s investment approach to respond to these.

Private equity deals appear to be slowing. What trends do you see in PE activity?

“As far as an overall trend, I think we may have seen a near-term peak in activity. There are several intersecting reasons for a period of digestion.

Firstly, there’s ‘The Denominator Effect’. When both stock and bond markets see correlated drawdowns and ongoing challenged performance, clients see these impacts on their balance sheets.

Given the delayed marks that can be seen in private equity, PE can become a much larger portion of a portfolio. If a family is targeting 20 per cent of its portfolio in PE, and they got to that level in 2021, they would most likely be showing a level of PE exposure closer to 23 per cent to 25 per cent right now. This happened because the 80-per-cent liquid assets may be down 7 per cent, so the overall denominator has shrunk.

Then there’s ‘Value of Leverage’. I think it is common knowledge that many PE strategies use significant leverage to acquire assets. Given that the cost of leverage has increased significantly, PE firms are more value-conscious on the assets they look to acquire.

Further, PE firms that may have used too much leverage in the 2018-2021 time frame may also need to focus their efforts on the businesses that they currently own and are not looking for large new deals. As such, the overall activity in the market is lower.

In terms of public valuations and M&A: With challenged performance in 2022 and for some companies into 2023, valuations of some publicly traded companies remain compressed. Thus, some companies do not feel they have the valuation or mandate from their shareholders to be acquisitive.

Then there’s the dearth of IPOs. In 2023, there were very few exits for PE managers via IPO. With less recycled capital, PE firms have less to re-invest.”

What about private credit?

“I would split comments on private credit into two categories: private credit focused on true yielding assets with moderate illiquidity risk, and private credit that was used as a replacement for private equity.

I think the opportunity for the former remains strong. Large banks simply do not compete in significant areas of the funding market that leaves strong yields available for good private credit firms.

However, there are large private credit funds that made loans against equity values of businesses with limited yield capabilities. These funds will have a difficult time surfacing value from loans, as the valuations of the companies they lent to have fallen.

If their investors want their money back and are redeeming, they may find it difficult to surface value from the illiquid companies to which they loaned money.”

Tell us about Viewpoint’s risk assessment strategy.

“Viewpoint employs a unique risk-allocation investment philosophy. Overall portfolio volatility and the contributed volatility of individual assets is a critical aspect to Viewpoint’s pooled funds and its approach to the construction of client portfolios.

Our goal is to build the most efficient portfolio possible from the available opportunity set and then scale the volatility of that portfolio to a risk level commensurate with client goals and expectations.

This may sound easy and most capital allocators talk about “risk,” but few firms have built the sophisticated models required to measure the volatility and correlation of every asset they own.

Without these two key measures, it is impossible to understand the contributed volatility of each asset to an overall portfolio. The level of overall volatility is a critical determinant in understanding the expected drawdown a client may experience.

Beyond our focus on volatility, Viewpoint also relies on a ‘stewardship framework’ that the Van Wielingen family developed with its advisors to guide its portfolio construction approach. This stewardship framework was a critical piece that supported the family’s diversification journey.

We now use this framework to help other families think about their potential transition from concentrated wealth in an operating company or in private and public equities to a more diversified portfolio.”

You have mentioned that the economic landscape in Canada has echoes of the 1970s. What are some aspects that will define this era in finance and how that relates to investing strategies?

“I would say the echoes go beyond Canada and are global.

As I said in my February 2022 Market Commentary, ‘the similarities between our current environment and the 1968-1975 period is quite uncanny. In 1968-1975, the “Nifty Fifty” drove valuations to extremely high levels, financial conditions eased dramatically by exiting the gold standard, and the Yom Kippur War tipped a tight commodity market into an inflationary crisis. Today, technology and “meme” stocks are leading a valuation surge, the COVID response has led to very easy financial conditions and Russia’s attack on [Ukraine] may be the catalyst for another inflationary crisis.’

Since this commentary, the similarities have continued to get stronger, with an emergence of geopolitical conflict in the Middle East and narrow stock leadership driving the stock market. The top 5 companies in the S&P 500 (Microsoft, Apple, Alphabet, Amazon, Nvidia) are approaching 25 per cent. The last time we saw concentration of this kind was when IBM, AT&T, Exxon, Kodak and General drove the “Nifty Fifty” peak in 1972.

Following the old adage that history does not repeat itself, but it often rhymes, these similarities are important to consider as they pre-dated a challenging period of inflation that did not end until the mid-1980s.

This period saw high levels of inflation that drove very problematic and correlated returns for both stock and bonds. Investors needed to have exposure to commodities to hedge the inflationary risk and generate solid returns.”

Viewpoint has been consistent in advocating for direct investment in commodities. Why?

“As a firm, Viewpoint holds that risk is tilted in favour of higher levels of inflation over the medium-term. Because of the risk of higher inflation, we think investors should consider an allocation to commodities as a value-added hedge.

The benefit from including commodities in a balanced portfolio is especially dominant during periods when stocks and bonds are exhibiting positive correlations, which is how we’ve been seeing correlations trend in a post-COVID world.

Periods of higher average inflation lead to higher levels of correlation between stocks and bonds. Also, both will have periods of challenging performance due to the impact of inflation.

During periods like this, commodities have been shown to be a value-added diversifier that helps to create a more efficient portfolio.

However, the very problematic performance of commodities from 2011 to 2020 has led many to conclude that allocations to direct commodities are not necessary in portfolio construction. If inflation stays higher for longer – in the 3-per-cent-plus range – the value of direct commodities in portfolios will become evident.

Viewpoint prefers to use a highly diversified approach to investing in commodities. It is very hard to determine where inflation will rear its ugly head, so we take a position to build a broadly diversified portfolio of 29 commodities across six commodity sub-groups: energy; industrial metals; value stores; grains; softs and livestock.

We believe this approach provides a broad exposure to inflation and will provide a more efficient portfolio that generates higher units of return per unity of risk.”

Responses have been lightly edited for clarity and length.

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