Crescent Grove Co-CIO Discusses The Effects Of The Banking Crisis On Fed Policy, Inflation And Markets, And How Advisors Can Hone Alts Strategies
Three weeks since the implosion of Silicon Valley Bank cascaded into the collapse of Signature Bank, a rescue of First Republic Bank, the purchase of Credit Suisse by its neighbor UBS and other instability in the American and European banking systems, all eyes are watching the Federal Reserve and Treasury react to this crisis in the midst of fighting inflation, market instability and a threat of recession.
To understand this new landscape and the ways advisors can leverage alternative investments to take advantage of the changes in store, we spoke with Andrew Krei, Co-CIO of Lake Forest, Illinois-based Crescent Grove Advisors, founded in 2015, which specializes in serving individuals, families, endowments, institutions and foundations.
Since year-end 2015, Crescent Grove organically grew its assets under management from $1.6 billion to $4 billion and increased its number of client relationships threefold. The firm has consistently allocated 15% to 25% to alternative investments.
We asked Krei how the banking crisis will affect Fed policy, how both of those will influence inflation and the markets, and how advisors can approach or change their approach to alternative investments in light of this unfolding landscape.
WSR: Tell us your thoughts on how the banking crisis that started with Silicon Valley Bank will evolve, end or change and what factors will drive that. How will that affect Fed policy on interest rates and quantitative tightening/easing?
Krei: There were certainly idiosyncratic factors at play as it relates to the recent bank failures, but as the adage goes, “There’s never just one cockroach in the kitchen.” In such a financialized world, it is hard to imagine that the Fed could raise rates nearly 5% over roughly 12 months without causing some degree of collateral damage. Until the Treasury explicitly guarantees bank deposits or the Fed reverses course and starts easing monetary policy, we expect more issues to surface across financial markets.
The Fed’s messaging last week gave a nod toward the elevated level of uncertainty resulting from the mini-banking crisis, but we do not expect the Fed to make a dovish pivot without an even bigger catalyst. With inflation continuing to run uncomfortably high, we see the Fed being more reactive than proactive over the coming months vis-à-vis market stability.
In other words, we do not expect the Fed to undertake anticipatory measures aimed at backstopping markets until inflation is trending closer to its 2% target. “Higher for longer” remains the base case.
WSR: How will the Fed and the banking crisis affect the course of inflation and markets over the course of 2023?
Krei: One-year inflation expectations – breakevens and swaps – were moving meaningfully higher earlier in the year but have reversed in the wake of the recent bank failures. In some respects, the recent tightening of financial conditions resulting from the mini-banking crisis should help the Fed fight inflation. Increased risk aversion in the banking sector should constrain credit growth, which would have a disinflationary impact on the economy.
Fed data dating back to the early 1990s shows that there have been four prior periods when a majority of banks tightened lending standards and, in each of those periods, the CPI declined meaningfully. They also coincided with stock market drawdowns, so we would caution advisors about aggressively buying equities in response to cooling inflation data.
WSR: In light of this, how should advisors approach or change their approach to alternative investments? Are there any particular kinds of alts or strategies for alts that you recommend advisors gravitate to or avoid?
Krei: In terms of the direct beneficiaries, we view the current environment as a great opportunity for private credit markets to fill the likely void created by small and mid-sized banks retrenching. Alternative investment managers in areas like private direct lending that target middle-market corporate borrowers or specialty real estate buyers may see less competition from the traditional bank credit channels.
That means lenders can push for more favorable terms – wider spreads, better covenant protections and lower leverage. Better terms typically translate to better returns for investors.
More broadly, periods of investor risk aversion have historically been associated with the best performing vintages of private equity funds. Valuation multiples tend to contract, providing buyers with more attractive entry points.
Segments like secondaries also become more interesting as existing private equity fund investors consider selling their interests – often at a discount to recent marks – to generate liquidity in their portfolios. Managers with strong sourcing capabilities and capital availability will be in a position to take advantage of these dynamics.
Michael Madden, Contributing Editor & Research Analyst at Wealth Solutions Report, can be reached at firstname.lastname@example.org.