Q2 2021 Putnam Dynamic Asset Allocation Funds Q&A
- Financial markets gained, aided by economic recovery, easy money policies, and global reopenings.
- We are bullish on equities over the next six months, pending the Fed’s move on rates and tapering.
- We are slightly bearish on interest-rate risk, as yields may trend higher on growth and inflation spikes.
How were market conditions in the second quarter?
Global financial markets ended the period mostly higher. Key equity market indexes advanced, driven by widespread Covid-19 vaccinations, fiscal stimulus, low interest rates, and signs of economic recovery. Stocks and other risky assets were under pressure periodically due to concerns that rising inflation and a speedy economic recovery could prompt central bankers to pare back easy money policies. The S&P 500 Index, a broad measure of U.S. stocks, rose 8.55% for the quarter after hitting records in recent months. International stocks, as measured by the MSCI EAFE Index (ND), climbed 5.17%.
Investor worries and recent volatility have centered around inflation and the Federal Reserve signaling they may raise interest rates sooner than anticipated due to the rebounding U.S. economy. These worries slightly subsided and markets calmed when the Fed called the rise in inflation “transitory” and stated it will not rush into raising rates. Some central banks across Europe and Latin America have already started to lift rates. However, the European Central Bank has pledged to maintain easy money policies. The rate-sensitive Bloomberg Barclays U.S. Aggregate Bond Index rose 1.83% for the period. The yield on the 10-year Treasury note, which helps set borrowing costs on everything from mortgages to corporate debt, fell to 1.45% at period-end from 1.74% at the end of March. The yield on the 2-year Treasury note advanced to 0.25% from 0.17%.
After a strong start to the year, commodity markets experienced further gains in the second quarter. Demand for commodities increased due to the reopening of economies globally, a return to international travel, and potential U.S. infrastructure spending by the Biden administration. Temporary supply bottlenecks caused by the pandemic also contributed to rising prices.
How did the funds perform?
The three Dynamic Asset Allocation Funds finished positive for the quarter. The Conservative Fund, with its more fixed-income-centric investments, rose 4.68%. The more equity-centric Balanced Fund and Growth Fund advanced 6.36% and 7.15%, respectively. All three funds outperformed their custom benchmarks for the quarter.
What strategies affected performance?
Dynamic asset allocation decisions were additive over the trailing three months. Asset allocations were adjusted at various points during the quarter to take advantage of what we viewed as tactical opportunities. On balance, the strategies were slightly overweight equity risk and credit risk and slightly underweight interest-rate risk. The strategies also had a long commodities position in place all quarter.
The portfolios were slightly overweight equity risk for the quarter, which benefited performance as major equity indexes soared to new highs. An out-of-benchmark commodities position, initiated early in the year and maintained throughout the quarter, was the other notable positive dynamic allocation contributor. What we viewed as bullish supply/demand dynamics suggested potential supply deficits. We expected vaccine rollouts, fiscal support, and easy monetary conditions to boost demand in 2021. This position was additive as commodity prices rose over the period.
During the quarter, our rates recommendation was decreased from neutral to slightly underweight given our belief that risks are skewed to higher yields. Our credit recommendation remained slightly overweight for the period. Neither rates nor credit positioning had a material impact on performance.
Security selection was positive across portfolios. In equities, quantitative strategies in U.S. large-cap and international developed markets continued their strong start to the year. In quantitative strategies, our team analyzes stock market history to identify characteristics of stocks (factors) that have excess risk-adjusted returns. Our momentum and research and development factors were two of the best performing factors during the quarter. Portfolios also benefited from fundamental equity-selection strategies, including our U.S. large-cap value and international developed sleeves. The Growth Fund experienced a gain from emerging-market equity selection. Opportunistic fixed income, specifically a strategy focused on structured mortgage credit, was also a small positive for the quarter.
What is your near-term outlook for the markets?
Widespread vaccine distribution continues to facilitate the global economic recovery and a return to normal life. We are encouraged by the current tailwinds for financial markets in the United States, especially the impact of fiscal stimulus, an improving labor market, and significant pent-up demand, which can help support recovering economies abroad. Still, we anticipate some volatility in the months ahead as investors weigh the continued rollout of vaccines and the pace of reopening, with its implications for inflation and higher interest rates.
Given the current environment, we are bullish on equities in the second half of 2021 until the Fed is close to signal-ing a taper of its asset purchase program. The combination of pent-up demand and the Fed’s accommodative monetary policy makes a compelling case for equities.
In fixed income, our outlook on credit is modestly bullish. Banks have eased credit conditions for large corporate commercial and industrial loans. In addition, average total leverage for new high-yield issues has declined to low levels that were last seen in 2013. Our outlook on interest-rate risk is slightly bearish, as we believe risks are skewed to higher yields given the expectations for continued economic momentum and the potential for an overreaction to some temporary inflation spikes. Upward pressure on yields could extend into the second half of the year as an eventual taper and change in the Fed’s rate policy slowly approaches.
Our view on commodities is favorable. We expect that increased distribution of vaccines, fiscal support, and favorable monetary conditions will stimulate global demand for commodities in 2021 from levels seen during the pandemic-induced downturn. Against this backdrop, we continue to have conviction in our investment strategies based on their strong long-term results.
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