2021 BEST IDEAS the FUTURE in FOCUS Pivoting from Uncertainty to Opportunity
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2021 BEST IDEAS THE FUTURE IN FOCUS Pivoting from uncertainty to opportunity. CONTENTS THE GOLDEN AGE OF CREDIT, 8 CONTINUED 4 MOVING OUT: THE GROWTH OF 6 THE SUBURBAN RENTAL MARKET ‘BRIDGING THE GAP,’ IN GOOD TIMES AND BAD 8 GROWTH IN A WORLD IN FLUX 10 ENHANCING RETURNS: 12 A PORTABLE ALPHA OVERLAY NEXT GENERATION OF DC: 14 TAKING AN INSTITUTIONAL APPROACH THE FUTURE IN FOCUS 2 INTRODUCTION The past 12 months have tested the world in ways that were hard to imagine last January. What started as a solid year for equities was turned upside down as the COVID-19 virus spread across the world in the first quarter, crushing global economies and virtually all asset classes and, more importantly, devastating the lives of millions. While markets have stabilized – and more – the longer-term impact of the pandemic is difficult to gauge, whether it be For investors, this all adds up related to healthcare, economic inequality, or how consumer and to more than just uncertainty. corporate behaviors will fundamentally change as a result of the outbreak. What can be assured, though, is that markets and It adds up to opportunity. investors will adapt to whatever comes their way. They always do. PAST WILL NOT BE PROLOGUE No one was ready for 2020, but we can be prepared for 2021 and, ultimately, look to a future we saw before the pandemic hit. And make no mistake, there’s far more on the horizon than the So, what follows here are some of those opportunities that we ultimate path of the coronavirus. The political backdrop over the believe are worth watching. We can’t be certain that all of our next four years will be much different than the past four. Central views will play out as expected, but we can promise you this: banks around the world will be grappling with the right mix of Our focus at PGIM has and always will be on the long-term stimulus (or, eventually, a lack thereof). Diversity and inclusion, trends and undercurrents that can lead to unique and untapped ESG and social equality will play far bigger roles in the political investment opportunities for our clients. and financial arenas. And China’s place in the global economy will continue to evolve, with potentially massive consequences. For investors, this all adds up to more than just uncertainty. It adds up to opportunity. Trends that were already in place prior to the pandemic are in many cases being accelerated, while new “As we enter a new decade, the global investment community and unique avenues of growth continue to be established, crisis is faced with a startling set of challenges.” or no crisis. Those were the very first words of last year’s inaugural Dealing with all of these issues – and myriad others – takes a Best Ideas report and well, we certainly got that right. manager large enough to have an established, global footprint, Little did we know how big those challenges would be. but flexible enough to adjust to rapidly changing conditions. A major advantage of PGIM’s business model is that we can offer our clients specialized expertise at-scale from businesses that are autonomous and nimble. THE FUTURE IN FOCUS 3 THE GOLDEN AGE OF CREDIT, CONTINUED Few people will have a difficult time watching the calendar flip past 2020. The reality, however, is that 2021 will no doubt bring its fair share of uncertainty as well, whether it be ongoing pandemic worries, geopolitics or an economic backdrop that remains unpredictable. The recent “phase one” trade agreement between the U.S. central banks around the world, in a moderately low economic and China eases some (but not all) of the uncertainty that was growth backdrop, tends to bode well for credit investors. hanging over global markets. Factor in the residual effects from We call it the Golden Age of Credit, and it has a handful of 2019’s broad easing in monetary policies, along with investors’ powerful drivers: ongoing search for yield amid generally limited supply, and the 1. Attractive valuations: While spreads have recovered from outlook for EMD appears broadly positive. their recent wide levels, they still offer long-term value. The Those near-term concerns are likely to keep corporations first leg of the credit spread rally in 2020 featured assets that conservative and focused on improving their balance sheets. And were directly targeted by various support programs, namely over the long term, the continued support of fiscal policy and high-quality assets. For example, AAA-rated securitized CREDIT SPREADS As of December 31, 2020 Spreads (bps)1 1 bps Spreads (bps) bps 2,500 Bank Loan 12/31/2019 3/31/2020 12/31/2020 2,500 Bank Loan 12/31/2019 3/31/2020 12/31/2020 US IG Corporates 93 272 96 High Yield US IG Corporates 93 272 96 2,000 High Yield US IG Intermediate Corporates 70 271 68 2,000 Emerging Markets USUS IG IG Intermediate Long Corporates Corporates 136 70 274 271 141 68 Emerging Markets USEuropean IG Long IG Corporates Corporates 93 136 239 274 92 141 1,500 Corporates EuropeanMunicipal IG Bonds Corporates 116 93 238 239 127 92 1,500 Corporates CMBS Investment Grade MunicipalUS High Yield Bonds 336 116 880 238 360 127 1,000 European High Yield 292 778 347 CMBS Investment Grade US High Yield 336 880 360 CMBS 80 207 94 European High Yield 292 778 347 1,000 Non-Agency CMBS 85 238 109 500 CMBSAgency CMBS (added 6/2014) 53 80 116 207 44 94 NonNon-Agency-Agency CMBS “A4A” Tranche 82 85 180 238 75 109 500 AgencyAgency CMBS MBS (added 6/2014) 39 53 60 116 39 44 0 NonAAA-Agency CLO CMBS “A4A” Tranche 133 82 268 180 123 75 Jun-04 Jan-07 Oct-08 Jul-10Jun-11Apr-12 Jan-14 Oct-15 Jun-17 AgencyEmerging MBS Markets 301 39 657 60 284 39 0 Dec-00Nov-01Sep-02Aug-03 May-05Mar-06 Dec-07 Sep-09 Feb-13 Nov-14 Aug-16 May-18Mar-19Feb-20Dec-20 AAAEmerging CLO Market Sovereigns 277 133 577 268 323 123 Emerging Market Corporates 311 599 328 Dec-00Nov-01Sep-02Aug-03Jun-04May-05Mar-06Jan-07Dec-07Oct-08Sep-09Jul-10Jun-11Apr-12Feb-13Jan-14Nov-14Oct-15Aug-16Jun-17May-18Mar-19Feb-20Dec-20 Emerging Markets 301 657 284 Emerging Market Sovereigns 277 577 323 Source: Corporates and CMBS from Barclays. Emerging Markets from JP Morgan. High Yield from BofA Merrill. Bank Loans from CSFB. 1Source of data: Bloomberg. Loan data on a week lag. Provided for discussion purposes only. Does not constitute a recommendation regarding the merits of any investments.Emerging Market Past Corporates performance is not a guarantee311 or a reliable indicator599 of future results.328 THE FUTURE IN FOCUS 4 products and high-quality, shorter-duration investment- stage, and while we believe ultimately that a U-shaped grade corporate bonds rallied strongly and largely recovered. recovery is the most probable, alternate scenarios cannot be However, the second leg of the spread recovery still has room dismissed. Nonetheless, we see a long road back to trendline to play out in some portions of the market. In particular, the growth, which should keep corporations in free cash flow credit crossover corridor of BBB and BB appears attractive. conservation mode for some time to come. In fact, the longer Historically, in the repair part of the credit cycle, fallen and harder the economic road to recovery, the more likely angels in the crossover corridor represent a “gift from above,” that companies will remain friendly to bondholders (or at and segmentation in the fixed income markets is particularly least less hostile). acute in the crossover corridor, which subsequently creates 4. Ongoing support: The global fiscal and monetary a meaningful source of potential alpha for multi-sector responses to the pandemic have been nothing short of investors. Default and downgrade activity could pick up astounding. These often-coordinated, swift and decisive materially should the economic environment deteriorate, actions arguably staved off the worst-case scenario for and credit selection remains paramount, but we believe the global economy and, thus, the markets. Crucially, the that spreads still provide investors with more than adequate economic state of the COVID-19 crisis is unlike the Global compensation for that risk. Financial Crisis, where fiscal and monetary authorities 2. Balance sheet repair: Credit investing is a rare world in were worried about “bailing out” bad behavior and actors. which not-so-favorable news can improve the investment The current lack of villains strongly suggests that both outlook. Essentially, credit investors benefit the most when governments and central banks will continue to do whatever companies are in free cash flow conservation mode and they it takes to support their citizens and the global economy. pull back on balance sheet destructive activities, such as share We see the post-virus world carrying forward many of the repurchases, dividends, and capital expenditures. We expect demographically related themes that have characterized the past corporations to embark on multi-faceted balance sheet repair decade — restrained global growth, low inflation (which will over the coming quarters and years. Provided that a company require central banks to remain stimulative), and low long-term doesn’t default, of course, the direction of a credit’s travel interest rates. This, in turn, should translate into a low volatility may actually be a better determinant of its performance, macro-financial environment. Taken cumulatively, we believe rather than simply assessing the current state of its credit that the sun is far from setting on the Golden Age of Credit.