The Inflation Playbook For HNWIs, With Lara Rhame

Inflation may have peaked in Q3 2022, but it’s likely to remain elevated into 2023. Moreover, as the year winds down, it appears that the Federal Reserve may be unable (or unwilling) to avoid a “hard landing” for the U.S. economy.

So what’s the playbook for family offices and High Net Worth investors? Lara Rhame, chief U.S. economist and managing director on the investment research team at FS Investments, joins the show to discuss which asset classes may be poised to outperform.

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Episode Highlights

  • An explicit year end inflation prediction from the FS Investments research team.
  • Why “sticky inflation” means the Federal Reserve is going to have a very hard time hitting a 2% inflation target.
  • Lara’s opinion on what the Fed fears most (and what this implies for the U.S. economy).
  • How asset allocation models are changing, and whether the 60/40 portfolio has truly “jumped the shark.”
  • Which three asset classes are likely to outperform in a higher-inflation environment, according to the FS Investments research team.

Today’s Guest: Lara Rhame, FS Investments

About The Alternative Investment Podcast

The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.

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Show Transcript

Andy: It seems like higher inflation is here to stay. So, what’s the playbook for a high-net-worth investor portfolio? Get the answer coming up. Welcome to the “Alternative Investment” podcast. I am your host, Andy Hagans, and today we’re talking about the economy and sustained inflation.

And what is the playbook for family offices, for very high-net-worth, ultra-high-net-worth investors who really are trying to maximize returns but, frankly, even survive the current macro environment? I’m very excited about today’s guest. Lara Rhame is a true expert on all matters macro, federal reserve, interest rates, inflation, etc. Lara, welcome to the show.

Lara: Thank you.

Andy: And before we dive into the inflation playbook, you’re the Chief Economist at FS Investments. So, could you tell us a little bit about your background and about FS Investments?

Lara: Sure. As you said, I’m the Chief U.S. Economist here at FS Investments. I’ve been with the organization for 6.5 years now, and we just celebrated our 15-year anniversary. We have $34 billion under management, all in alternative assets. And we really span the range of private credit to global allocation through a mutual fund, and we also span the range of liquidity because I think something you quickly learn as you dive into alternatives is that the structure needs to match the actual investments.

And my role here is really to help our investment managers and the organization guide our macro-outlook. So, I think when I was first interviewed and first hired and I came from a long history of working at the bulge bracket sell-side firms up in New York, we’re in Philadelphia.

And my question was, how hard do I need to sell what we’re trying to sell? That had always been the thing at these large sell-side firms. Like, we’re wrapping up our EM desk, we want you to sell emerging market debt. You’d always be selling equities, things like this.

And their answer was, “We just want you to be thoughtful. We have confidence that our funds are going to sell themselves. We really want to raise the brand awareness and the thoughtfulness.” So, that was six and a half years ago. I think it’s true to this day and to me really makes my job so much more fun because there’s a really important space in every portfolio for alternatives.

I think that case has really only gotten stronger, and 2022 so far has been a painful example of that.

Andy: Well, as an unofficial representative of the alternatives industry, I guess I would say this is our moment to shine. IPA, one of the major trade organizations representing the alternative space, they always use that phrase, “portfolio-diversifying alternatives.”

It’s kind of a mouthful, that adjective, portfolio-diversifying. But it really is like, “This is why this environment where bonds are down, equities are down, inflation is high.” If you invested in alternatives and made that allocation, whether you’re an REA or family office if you made that allocation five years ago, you’re probably feeling pretty good about it right now, wouldn’t you say?

Lara: I would agree. I mean, I think that something striking has happened this year that correlations have increased amongst markets and especially amongst all of these big traditional indices. We used to think about diversification as needing to sort of tinker with in the S&P 500.

Are you looking at consumer staples? Are you looking at tech? And that was your idea of diversification. You had stocks and bonds were supposed to diversify each other. Well, guess what? This year, their correlation has really skyrocketed. They’re not diversifying each other at all.

And this is something that I don’t know what questions you are asking people get into it. But I think it’s really critical because one of the things that I have been trying to shout all year is that you need to be tearing apart your portfolio and really re-examining what true diversification looks like, because you’re not going to get it from the typical, sort of, stock-bond blend that I think so many of us got comfortable with for 25 years when inflation was really low.

Inflation changes the dynamics of that diversification.

Andy: Things stay the same until they don’t, right?

Lara: Yeah, and we shouldn’t feel bad about getting complacent. You know, we had low inflation for 25 years. We’re all creatures of habit.

Andy: Right, right. So, that brings me to your research team, and I’m going to bring this up on my monitor here. The report that you all published was titled “Charted Territory inflation Playbook.” And I love that charted territory because you’re right, it’s not the first time that we’ve seen higher inflation.

Although there are some changes, there are some demographic changes, there are some other changes.

Lara: Oh, yeah

Andy: And by the way, for our listeners and viewers, I’m going to link to this report in our show notes so that everyone can access this report. But I want to start with your team’s inflation prediction. I love it when research teams make an explicit prediction. It’s like, “Tell us what you really think.” So, we can expect a bit of disinflation now, or deceleration, as I think the report refers to it.

I recently had Colin Roche on the show and he basically said, “Look, it looks like inflation has already peaked. We’re already just inflating.” But a lot of these numbers, the Fed looks at backward-looking data, essentially, but your team expects us to be at that 5% to 6% inflation range year over year as we end the year.

So, you’re expecting basically two and a half, three points of disinflation even between now, early October, and January 1st.

Lara: So, you know, I think we’re really looking at closer to 6%, but yes, from where we are right now. And let me just back up a second, if I may, Andy, because I think something that’s so important to understand is that when I was a girl in the ’70s I remember the last time we had inflation this high.

I remember the oil scarcity, the gasoline scarcity. I had to wait in the back of the car because you can only get gas every other day depending on the last digit of your license plate.

Andy: Oh, wow.

Lara: So yeah. So, I have this economic memory of when inflation was that high. But I think it’s really important to appreciate that it truly skipped a generation. I mean, we’ve had from the mid-’90s until before COVID, 25 years of inflation that was very close to 2%. It didn’t deviate a lot.

You had an energy price shock around the financial crisis, but it came back really fast. Core inflation really did not deviate significantly from that 2% for any length of time. So, it was low inflation, low volatility. And if you think back to the early 1980s, the last time that inflation was as high as it is today, the 10-year treasury was 13% back then.

Today it’s back down to three and a half, or it’s been really a lot. You and I can barely keep track of how fast it’s moving, but I would argue that even if there are folks like me who have this memory of what the economy was like, investors are in totally uncharted territory when it comes to how to manage portfolios through this higher inflation.

So, getting back to the question at hand, the outlook for inflation, sure, I agree. Oil price spike possibility notwithstanding, we may well have seen the peak year-on-year number, but what we are seeing now is inflation just bubbling up from virtually every sector of our economy.

And so, while you do have cases, clearly we’re past the worst like used cars, which is something that we’re going to talk about, I’m sure. You have some of these cases where it was up 30%, 40% at the peak. There was a time where used cars alone, and that’s a small piece of the index, was adding over half of the monthly gain in CPI.

That could well reverse or at least see some price decline.

Andy: Sure.

Lara: But that doesn’t change the fact that we’re seeing higher food prices, higher rent prices. You just, kind of, do a round-robin of sectors of our economy. And this is consumer price inflation, right? It’s what is impacting our household budgets every month. You know, I hate to sound like the mom when I talk about this stuff. I do the grocery shopping.

We all feel the pain of higher food prices. And so, you kind of do that 360 of every sector of our economy and you are seeing pervasively higher inflation than we had prior to COVID.

Andy: So, Lara, it sounds to me like some of the real outliers, let’s put energy aside for a moment, but like some of the extreme outliers, like used cars, they’ve maybe already rolled over. We’ve seen the worst, but the corpus, the meat of this higher inflation is still here to stay.

So, it’s like when you cut away those kind of outliers, the used cars, the computer chips, whatever, what have you, that may be the stimulus checks, you know, some of these one-time events or whatever, it’s still as you predicted, closer to 6%. That’s still pretty high as kind of a default rate.

Lara: It’s high and it’s far from the Fed’s 2% target. As inflation rose, we all saw the Fed mistakenly, now we know in retrospect, describe really point to these one-off factors and point to them as transitory. I think watching their language on the way down will be critical because we’re probably going to get choppiness in the monthly numbers related to some big swings in some of these durable goods or some of these one-off sectors.

But now, given that we’re just seeing this broader based increase in rents, which is the Fed likes to differentiate between sticky prices and things that fluctuate quickly and rent is sticky, medical care costs are sticky.

Andy: Sure

Lara: There are things that really make employees go to their bosses and ask for higher wages if their rent has gone up 10%.

Andy: So, that’s the wage-price spiral, was that what I remember from my college?

Lara: That is the worst-case scenario. That’s what the Fed is just so eager to avoid. And you know when…

Andy: We’re not there. Are we there already?

Lara: Well, this is the tricky part.

Andy: Or are we not there?

Lara: Wages are higher. Wages are also sticky. They take time to move, no matter how hard I’ve been trying. But at the end of the day, we’ve seen wages up 5% year on year. That’s versus 3% before COVID, but it’s far less than inflation. So, I think if we settle at the end of the year, sort of, Q1 around 5%, the big question we are all going to be asking ourselves is, “Is that inflation low enough for the Fed to, sort of, spike the ball and declare victory or are they still going to keep rates high and be hawkish?”

Because if they are slowly going by their 2% target, 5%, it’s better than 9%. But it’s really to them, I think, still an unacceptable rate of inflation.

Andy: I personally and I don’t really know anything, but I don’t see it. I don’t see them. I think it’s a question of what are they more afraid of. Are they afraid of inflation in the fives or are they afraid of a recession? I think they’re afraid of inflation sticking in the fives.

I mean, I think we’re already in the recession, right? The thing is, recessions, my point of view, I don’t know if the Fed agrees with me, they don’t have to be that big of a deal, right? Like, they’re not all 2008, 2009 type recessions. I mean, think back to 2020 like the little flash economic slowdown we had that lasted all of, what, 60 days or something.

So, they don’t have to be that big of a deal, but like a permanent or indefinitely higher sticky rate of inflation at 5%, that’s a huge deal. And I think even if their target is 2%, that might be their stated target. Maybe they’re thinking, “Well, if we can even get it in the 3s. If we can even get it to 3.75.” Everyone is going to take a deep breath and say, like, “Okay, ah, we’re in striking distance of normal.”

Personally, I think that’s where they probably feel like they can relax a little bit. What do you think?

Lara: Yeah, boy, and this is something that I’ve just been thinking about non-stop. I agree with several things you said. I’ve been reminding people that the last two recessions were particularly crazy. We had the Great Recession accompanied by a financial crisis that is not normal. And it just lasted for so long, six, seven quarters.

And then, you know, just the epic dislocation that we had in jobs and activity, it was short-lived, but it was a zombie apocalypse. The pandemic was really scary and it resolved, but boy, it was really disruptive. But we’ve had recessions in the early ’90s, in the early 2000s that didn’t take years to recover the lost income and jobs and output.

They were really, sort of, shorter-term events that we were able to recover through rather quickly and I think… So, you know, the label recession has just been really tricky this time around because, you know, we’re getting these really conflicting signals.

Growth is arguably extremely weak, but unemployment growth is still really strong, but that’s backward-looking. Unless we go into next year, I think there are folks like me who are actually worried that we really haven’t seen a recession yet. We’ve just seen really sluggish growth, and that could be waiting for us in 2023 along with the more typical collateral damage of some job losses.

Andy: Well dude, I mean, is there an argument that we need a recession? I mean, asset prices, some of them at least, just got out of control. I mean, you shouldn’t have a…you know, housing prices shouldn’t increase 20% year over year. That’s not healthy. That’s not sustainable. So, a little bit of a giveback might be a good thing, right?

Lara: Yes. I think that the Fed, and we all know this, right? They’ve painted themselves into a really tough picture. They’ve painted themselves into a tough spot over the last two years and this happened… And this circles back to something else you mentioned, which is so critical, which is the fact that what do they care more about, the recession or higher inflation?

I think maybe this is off consensus. I think they are facing an existential threat to their own credibility. I think they are now so worried because they dropped the ball so badly on this inflation front that they are having to claw back their credibility.

That comes at a price.

Andy: Well, Colin Roche, who I had on, he basically said, it’s amazing. They know they’re making a “mistake” right, and they’re willing to make it. And I said to me, that actually makes sense. They’re willing to make a “mistake” but they’re not willing to repeat the mistake that they just made, which was underestimating inflation.

They’re like, “We’re okay with pretty much any other bad outcome except for that one. Except for us saying out loud, we’re taking on inflation, and then three years later, we have totally failed. We have egg on our face.” That’s like the one thing I think they will do anything to avoid. And honestly, I think rightfully so, because again, a recession, of course, there’s dislocation, there’s businesses that go under, but in the larger scheme of things, it’s not really that harmful to an economy.

But sustained inflation over, like, let’s say a decade could be very harmful.

Lara: Yeah, and I think they also are looking back at the ’70s. They’re seeing when they cut rates too early back then and inflation research. So, I think exactly to your point, and they probably made a mistake with quantitative easing as well. They kept it going for too long, they clawed it back fast.

But the reality is, through the last 15 years and the 2018 tightening cycle, the Fed is now having to push back hard against market expectations that they’re just going to be cutting rates next year. The reality is, with inflation at 5%, which is my outlook for sort of deeper into 2023, that it persists.

That’s not a place where they can start comfortably, really cutting rates significantly. And so, we all talk about the Powell Put, right? That’s it, that’s what they’re pushing back against, this idea that they’re going to be there to rescue markets.

Andy: Well, you know, the interesting thing is there are things that are outside of their control, right? So, I agree that they made mistakes in 2020. I mean, that’s obvious. But it wasn’t their decision necessarily to, like, shut down the supply chain. It was a political decision, you know, all these stimulus payments and extended unemployment payments.

Essentially what we did politically to inject a ton of cash into the system on the consumer side, creating all that additional demand at the same time that we’re constraining supply. So, another concern that I have is even as the Fed is being more aggressive and signaling that they’re going to be more aggressive, we’ve also had recent legislation, the Inflation Reduction Act of 2022, or recent executive orders like the student loan forgiveness.

And these are things that are outside of their control, that are injecting, I guess I’d call it, more demand into the…more dollars sort of sloshing around. Is that a concern?

Lara: So, you know, and I think what you’re pointing out is critical because when we think about the way that rate hikes are going to slow the economy, the reality is there are a lot of things adding to inflation that rate hikes aren’t going to address. So, this is something that I think when you look at where inflation is coming from, some of it are things that Fed rate hikes will control.

And other things are just beyond the scope. Russia invading Ukraine, pushed up wheat prices, pushed up commodity prices, the whole commodity complex. That’s not something that their rate hikes are necessarily going to be able to fix tomorrow. So, against this backdrop, I agree that the Fed rate hikes are a broadsword, right?

They’re not a scalpel. So, that, I think, is true. But when you look at, I think, some of these targeted fiscal stimulus efforts, I do think… I’ve long said this, I don’t have a problem with the government spending money. I just think we need to be tactical about what we spend it on. And so, I think if this was branded as the Inflation Reduction Act, because obviously inflation is the buzzword that everyone’s pushing back against, I think that it does make a lot of sense for us to subsidize domestically driven business investment.

And again, deglobalization is not just something that we are pursuing. It’s also happening to us at the same time. Again, after I get 30 years of moving towards global supply chains, really, in retrospect, the U.S. economy was a monument to global supply chain efficiency.

I realized how fragile that was. So, as we walk that back, it’s not entirely a bad thing.

Andy: Well, so, I agree there, like, in terms of national security, even like, or in terms of certain types of blue-collar manufacturing jobs, like, all these sorts of good things about the reversal of the trend of globalization. I mean, there are some good things about globalization, but there were some not-so-good things about it, right?

But by reversing that trend of globalization, isn’t that just creating this inflationary pressure that’s just going to kind of stick around?

Lara: Yes, that is exactly right. And that is something that I think is underappreciated. When we look back at the 30, I know this sounds like we should be talking about what’s happening right now, but we are, even though we’re talking about it in terms of decades-long trends.

Andy: Sure.

Lara: When we look at the multi-decade trend of globalization, one of the reasons why our economy was able to manage very low inflation was because we had this canopy of durable goods price deflation, right? Remember disinflation is when inflation is still positive, but it’s falling. It’s like a deceleration.

Deflation is when prices are contracting. So, if you look at the price of cars, the price of computers, the price of a lot of our non-durable goods and all of our durable goods, they have been falling for 20 some years.

Andy: Even food, right? I mean, a loaf of bread, Coca-Cola…

Lara: Almost zero. Yeah, it was almost zero. And so, I think this is something that’s underappreciated, a world where that’s even less global. We’re still going to be a global community, it’s still going to be a global economy. But even if we just bring walk back some of that deglobalization, we end up in a net higher inflation world.

And that is the reason why I wrote this playbook because I think that investors, I’m, kind of, right back where I started, but I think investors need to appreciate that this isn’t a flash in the pan of higher inflation and it’s not going to come back together again in a neat 2% bundle like we had for so many years.

The genie is really out of the bottle. It’s going to be really tough to get it all back together again. And geopolitics is a part of that, U.S. policy is a part of that, and these big globalization trends are a part of that.

Andy: And so, do you see that as, you know, that meaning everything we just described, those macro decade-long trends, tailwinds that are pushing inflation up, is that what’s going to cause the sticky inflation? Or is that more an artifact of, like, consumer expectations or employee expectations? Is that what the sticky inflation is?

Or am I…

Lara: No, I think it’s the former because again, another trend, and this is highly ironic. We talked about housing earlier, Andy, and this is something that I think people don’t appreciate. The millennials are, sort of, the sleeping giants demographic. They’re the tectonic plates of what I do, these slow-moving trends, but they’re really unavoidable.

And the millennials were delayed in trying to buy homes, and now they really came in. Obviously, the pandemic played a part. Low-interest rates and this big demographic push of people who delayed wanting to buy a home raced into the market.

And we underbuilt homes because of the financial crisis and its basis in the real estate market. So, this has all come to a head. And ironically, the Fed’s rate hikes have crushed the home builder market. So, they’re hitting supply at exactly the wrong time, and it’s actually amplifying this demand for houses. So, you know, you own a home, it’s a good thing, but…

Andy: Can I pause that?

Lara: Yeah.

Andy: So, just stick a pin right there, that comment that you made, that it’s exactly the wrong time because I feel like the mortgage rates have obviously gone up. We’re seeing inventories rise in some markets and I talk to real estate investors all the time, like, that’s what we do at AltsDb. And it’s weird because nobody’s really panicking. Like, it kind of feels like, “Wait, can I…”

It’s like there’s a voice in the back of your head like, “Wait, aren’t I supposed to be panicking right now?” But I think there’s just like this sense, a lot of sponsors, a lot of family offices, that they see exactly what you’re saying, which is like, “Look, there’s nowhere to hide. There’s no five million houses that are hiding right now that are going to appear next year.” And so, if inflation really is sticking at 5% or 6%, so what if the housing market, let’s say, takes a 10% haircut in the next year or what?

Like, it’s got nowhere else to go but back up because there’s just not enough homes to go around.

Lara: I think that is exactly right and I would really echo that because… And obviously, real estate is so locality driven. We’ve seen some markets experience explosive growth in other markets, like Philly, have not seen significant price appreciation a little bit, but we’ve lagged South Beach or Miami.

But this is really critical because unlike the financial crisis, where we had way overbuilt both on the commercial real estate side and the residential side, we have not done that over the last 15 years. And so, it’s one of the reasons why, and I’ll layer onto that and this is where I’m interested in your opinion on this, you know, this back to work or work versus work from home.

I think we’re seeing, you know, even as we feel like our economy has gotten back on footing, the reality is office occupancy is 47%, what it was before COVID, that is extraordinary. And think about people spending…

My colleague Andrew Kors, who’s written a lot about real estate, estimated that people are spending 21% more time at home than they were before the pandemic. Well, that means that you’re going to value your home more, you’re spending more time there. And so, we were just talking today, I think, you know, as real as the…how the construction numbers have fallen, but the home improvement numbers are really rising.

This is a place where I think the investment pivots. Because mortgage rates are so high, people are going to still be trying to improve the homes that they’re in now. I think that’s the next wave that we’re going to get, just because arguably, given how fast mortgage rates have moved, it takes time for that to work its way through into the top-line pricing.

What you tend to get is number of transactions freezing up first. But I think real estate is still going to be a really important part of real asset investing in the next year.

Andy: Yeah, so let’s talk about those fundamentals. First of all, I totally agree. This was a secular permanent shift. It doesn’t mean offices aren’t going to exist anymore, but that 47%, 48%, whatever the exact number, that’s not going to go back up anywhere near to what it was. But we saw home prices rise so quickly, and of course, we also saw rent…

Rent went way up, but it did not gain on a percentage basis nearly as much as the asset prices did. So, from where I sit, not a mathematician, not an analyst, but it seems like there’s almost a margin of error if you are an investor in real estate, if you’re owning for cash flow, talking about multifamily assets, those types of assets where asset prices could even fall by 10%, that doesn’t mean that rent is going to be flat.

It’s not going to fall 10%, but I don’t even think it’s not going to be flat, right? Those didn’t move together necessarily in the last 24 months. So, I don’t know that they need to move. And so, if mortgage rates are in the fives and the sixes, whatever, if inflation is in the sixes, just in the abstract, this doesn’t feel like a bad deal for me.

Lara: Right. I think that’s really important. We’re supply-constrained and this is an important dynamic of inflation. Just because prices stop rising doesn’t mean they’re going to fall back to where they were. Again, I argue that for rents.

We saw a very unique episode of rents in New York City, for example, falling during the Pandemic, but we don’t expect that now. There’s evidence that rents have stopped rising. But again, I’m talking about residential rents. Office rents again, may be different and it’s very locality driven, but when you look at those multifamily…

The construction numbers for multifamily continue to look good. There continues to be demand. And I think that’s, again, a place where we’ve had construction really lag for years and years and years. So, yeah, I think the math still adds up, especially at a time when interest rate… You know, safer credit interest rates are negative.

Andy: That’s exactly it.

Lara: You know, real rates are negative.

Andy: It’s negative interest rate on a real basis.

Lara: Exactly. And inflation really, kind of, eats the stock market first selectively. Real assets are the target that need to be more heavily revisited in this environment because equities especially, look at where the S&P 500 is weighted, it is a massive overweight towards these international large-cap, multinational tech companies.

Well, guess what? Strong dollar hurts those guys. Higher interest rates hurts those guys. And then the inflation on top of it. It’s just kind of a perfect storm. And that’s why you’ve seen that top-line grouping just get hammered so far this year and I don’t see that changing in 2023.

All these dynamics are going to continue to be in play.

Andy: Well, that’s interesting. That brings me to another topic, which is portfolio construction. And so, we’re talking in the context of high-net-worth investors, family offices, and maybe even institutional investors. We’re all navigating the same environment. And I think that’s really top of mind in the alternative space where everyone’s taking a look at that 60/40 portfolio.

Even those of us who have moved past it, it’s still kind of that reference point. And looking at the bond portion of a portfolio, I mean, real yields on bonds are negative, right? I haven’t looked at junk bonds lately, but I assume even they’re yielding negatively, especially on an after-tax basis.

How long can that last? This entire section of the market just has a very negative yield.

Lara: Yeah, so, your junk bonds are positive-yielding. Again, it depends on where you are along the spectrum. High yields, 10%.

Andy: And that’s pre-tax, right?

Lara: Yeah, inflation’s 8%. Pre-tax, yes, yes. Yep, that’s right. But investment grade, treasuries, deeply negative yields. And so, when we think about portfolio construction, we really do think about trying to find those uncorrelated assets. When we talk about commercial real estate, we’re looking at it from the debt side because we don’t want to remark our net asset value, we want it to be stable.

We’re looking at energy, which oil is sold off, but I see upside from here, especially going into winter. And it’s not just oil, it’s the entire energy complex. It’s the fact that the shift from traditional energy to electric vehicles over the next five years is just a place where energy is going to continue, I think, to be something that is subsidized.

We’re going to continue to get demand for it, and I think it’s an important place for that real asset investing for materials. One of the things that we’re seeing, and this is where inflation is a game changer, business investment has been remarkably resilient.

And again, it’s not necessarily a bad thing going forward for our economy. It would be great to get… We’ve under-invested in our economy. Our businesses have underinvested for years. So, that would be an important positive. And materials companies have done well. The companies that have the input for what you need for that CapEx spending have done well.

So, these are places there are pockets of the equity market that we’re accessing. But when we really look at portfolios, it’s realizing that you need to… And I agree, we still kind of benchmark to the 60/40.

And I feel like that’s the cocktail party discussion because it’s what we kind of look at our phones every day. Our private investments aren’t listed on our iPhones the same way that our stocks are in the S&P 500. So, that kind of ends up being what’s still top of mind day by day.

Andy: Well, let me actually ask you to put you on the spot with FS Investments. I mean, I know you all have a lot of products, interval funds, BDCs, all kinds of different alternatives products. But I’ve always felt you have the 60/40 portfolio and then we have these alternatives with varying degrees of liquidity, right?

Some of them more liquid, some of them less liquid, and some of the ones that are less liquid. In my mind, they’re probably just as volatile as those more liquid markets, so the equities market and the debt. It’s just they don’t get repriced every day in real-time. But then there are other types of alternatives that truly do zig when the market zags, are just a lot more resilient where a year like this, they’ll turn into 4% positive return or 6% positive return.

So, how do you see the alternative landscape? Are alternatives on the whole? Are they broadly delivering what they’ve advertised to REAs, to high-net-worth investors as that, sort of, ballast in a portfolio during a year like this?

Lara: I think they have. You know, it’s such a broad category to try to summarize, but I think that if you look at what few assets are up, look at leverage loans, they’re down 2% versus the traditional indices.

You know, you can really pick apart so many different asset classes and even within that find winners and losers.

But I think that if 2022 has done anything, it’s really proven that we need these non-correlated assets in our portfolio and we really need to, you know, I just think we need to rethink how we consider diversification. And again, I think for so many years it was like, large cap or small cap?

Well, they’re all moving together. So, we really need to just… That is what I think of when I think of reconsidering diversification and I think it is important, your point about structure and liquidity and I’m happy that your audience is really filled with people who probably are taking a longer view on things.

I feel like I’m smarter than the average bear when it comes to finance and I’m smart enough to know that I cannot time the market. And I have always discouraged anybody from thinking that they are that smart. Maybe you get lucky sometimes but the smartest investors really know where they’re not smart. You want to, I think, be leaning in.

Even if you’re leaning into the macro story, timing that is really difficult. Managing through this volatility has been terrible. You know, the August rally, we’re rallying today but last week it was doom and gloom.

I mean it’s just been really, really volatile. So, I almost…

Andy: And I can never make sense of that, which is the logic… Maybe you could tell.

Lara: It’s all gotten noisier.

Andy: Well, it’s the logic that when the news is bad, then we think the Fed won’t really go as far as we think. So, then we think they’ll be nicer. Is that the logic? The bad news is good like…

Lara: That’s exactly the logic. And I would layer onto that the fact that the interest rates have come down. Again, this is a place where just stocks and bonds are not diversifying each other. They are highly correlated with each other. So, when your bonds are rallying, your stocks are rallying, and guess what? When stocks sell off, it’s often because bonds have sold off and the yields are higher.

So, that is what we have seen all year and it is striking. And I think this is something that is being amplified by poor liquidity in the treasury market. We could do another podcast solely on that topic. This is something that is really causing volatility around markets. But it’s one reason why I think the smarter folks like in the family offices, like the REAs, they are taking a longer-term view.

We’re making wine that takes five to seven years from the time you plant it to the time when you’re harvesting or even longer. You can’t have a short-term view. And so, I think they’ve known the importance of alternatives. We at FS try to take that to every…we really try to democratize it to every investor because a lot of people just think that they can do it themselves with their account and their S&P 500.

And the reality is that you should be accessing some of these structures and they may be a liquid but that’s where you can truly get outside returns in a very difficult market.

Andy: Yeah, plus the diversification. And so, that brings me back to this report, and it references the winners in this type of period where we have these sustained periods of higher inflation. And so, in the report, top three performers, number one real estate, number two commodities, number three infrastructure.

Do you think that’s going to be the case over the next couple of years?

Lara: Well, absolutely. I mean, you look at the job losses or what make the headlines. What doesn’t make the headlines is companies spending hundreds of millions of dollars building new plants, companies going in and building new headquarters. These are things that I think we’re going to continue to see.

The demographic trends strongly points to the need for more housing, for more commercial real estate. Again, you have to be selective, right? But I think everyone got really nervous when Amazon said they kind of overinvested in industrial. If anything, the last 10 years has shown us, it’s that Internet shopping is going to continue and sort of this, you know, inventories.

Not a surprise to me that inventories ended up higher than they did before COVID. Look at the inventory drawdown and the difficulty that companies had maintaining sales when the supply chain got disrupted. Of course, inventories were going to end. We’re going to, kind of, find a steady state at a higher level. And I don’t think that’s a mistake.

I actually think some of it’s by design, and they’re going to need the place to store that stuff.

Andy: So, you’re not seeing the panic setting in the corporate world with the rising inventories?

Lara: No. And I think, you know, obviously, there are too many fire pits stored. Nobody needs two fire pits. Everyone bought one and now they have one. But beyond that, I think that we’ve worked really hard to overcome these supply chain disruptions, and to me, sort of coming to rest in a place where inventories remain higher than they were before COVID makes a ton of sense.

So, for this reason, I stand by where we think our winners are going to continue to be in this higher inflation environment. And this is something that I think we’re naturally under-invested in. That happened because we had low inflation for so long, and it’s not something that’s just going to be fixed over the next several months.

And therefore, you need to be building a portfolio around the idea that we’re probably going to have persistently higher inflation.

Andy: Words of wisdom to live by, Lara. I love this conversation we had today. I hope we can have you back on the show. Honestly, I feel like we should probably have you on, like, every month or something because the news is just… honestly, there’s so much, it’s hard to even…

Lara: It’s true.

Andy: …keep up with it. But that being said, where can our viewers and listeners go to learn more about FS Investments as well as your research?

Lara: Well, I’m on Twitter, Economist_Rhame. And our website,, has all of our content. Anybody can go in, download it, it’s all for public consumption, and sign up for our mailing list. You can sign up for my stuff.

Specifically, our entire team looking at credit, real asset, cross-correlation, cross-asset allocation, and our playbooks, of course, we’ve written on globalization, what happens when your portfolio is all highly correlated playbook. I’m working on a strong dollar playbook right now, so I think it’s a really good way to dip your toe into our content.

Andy: Yeah, I have to personally compliment the FS Investments team. I love these playbooks and I love that your research team and you all have the confidence to make these calls, to publish them publicly for everyone. So, I really recommend these reports. And for our listeners, I’m going to make sure to link to them as well as to the FS Investments stuff and to all of Lara’s social media so you can follow along and get some of that valuable research.

We’ll be sure to put that in the show notes at And don’t forget to subscribe to our show on YouTube and on your favorite podcast listening platform so that you can be sure to receive our new episodes as we publish them. Lara, thanks so much for coming on the show today.

Lara: Thank you so, so much.

Andy Hagans
Andy Hagans

Andy Hagans is co-founder and CEO at AltsDb, and host of The Alternative Investment Podcast. He resides in Michigan.