WHAT OUR MANAGERS THINK…

…About THE ECONOMY

FRANKLIN TEMPLETON FIXED INCOME

Potential for strongest consumption boom in decades

• The reflation consensus is being fueled by three catalysts:
  1. 1.The economy’s previous ability to bounce back when restric­tions were lifted
  2. 2.A growing sense that the pandemic may finally be coming under control, as cases trend lower across the United States
  3. 3.Both fiscal and monetary policy­makers are determined to err on the side of “overheating” the economy
• The US economy is poised to experi­ence the highest levels of real GDP growth in nearly four decades in 2021; the staggering amount of fiscal stimulus, combined with upwards of $2 trillion in excess savings after the next round of government transfers, could fuel the strongest consumption boom in decades.
• We expect that the coming quarters will see a consolidation of a robust recovery in the United States and in the global economy at large, with Europe catching up in the latter part of the year.
• We believe this unprecedented onslaught of policy stimulus greatly increases the chance that the US economy will overheat over the course of this year and next.

CLEARBRIDGE INVESTMENTS

Tsunami of stimulus

• We are very positive on the economy and market as we march towards herd immunity and the normalization it brings.
• The fiscal policy response to COVID-19 has far surpassed the total response to the past five recessions combined.
• Pent-up consumer demand is already well funded thanks to this tsunami of stimulus.
• On the corporate side, balance sheets are flush with cash, accumulating an additional $500B since the start of the pandemic. These funds could be used for growth activity such as hiring, capital expenditures or inventory building.
• We are not naive to the risks that exist, including complacency on the prospect for higher rates despite history suggesting that yield curves steepen as economic expansion builds.
• An overshoot could lead to more volatility, potential short-term downside and further recalibration of equity market leadership.

…About US EQUITIES

CLEARBRIDGE INVESTMENTS

Growth companies need to deliver on rich valuations

• While the reopening of the global economy will lead to more normalized business and consumer trends and a broadening of companies that participate, we believe innovative businesses should continue to outperform over the medium to long term.
• Beneficiaries of work-from-home and e-commerce trends continue to disrupt their target markets by enhancing the products and services they deliver—e-signature and telemedicine providers, for example.
• We have confidence in a number of software names held back by COVID-19 related delays in adoption or implementation that support digital transformation: technology enablers of electric vehicles and solar energy, and online dating platforms that have filled the void resulting from a lack of social interaction.
• Valuations have been stretched in younger growth names in more speculative areas. We believe growth investing will be more challenged than in the recent past when the fastest growing/highest multiple stocks outperformed by a wide margin. These companies now need to deliver on the promises implied in their rich valuations—and many won’t achieve that. That’s why we believe active management is as crucial as ever.

FRANKLIN EQUITY

Leadership shift won’t nix innovation backdrop

• Recently, we’ve seen shifts in market leadership toward value-oriented and cyclical names with signs of the reopening.
• Even after the strong performance of the past year, we continue to think we are experiencing a very rich backdrop to invest in innovation as many discrete advancements are becoming economically viable.
• Investors often underestimate the duration of growth that innovative companies can generate; many grow and generate excess profits for very long periods of time.
• Some consumer shifts of the past year are likely to be permanent, including online shopping, contributing to increased investment in related industries like logistics, online payments and web services.
• Genomics continues to be a key area of innovation. Genomics and gene sequencing were major contributors to finding therapies and vaccines for COVID-19. Now, we have not only fast-tracked therapies, but we have also built distribution and manufacturing capabilities that could make genomic advancements easier to implement in the future.

ROYCE INVESTMENT PARTNERS

Intra-cycle rotation should lead next small cap leg

• After a robust run for small caps since Q3, we see increased volatility as a healthy sign for the market as a whole. We expect lower, but still positive returns for small caps over the next several years.
• We think the market’s recent leadership rotation from large to small is sustainable. Apparently rich small-cap valuations are offset by likely trough earnings in what remains a very low interest rate environment. Small caps remain far less expensive than large cap peers, as measured by EV/EBIT (enterprise value/earnings before interest and taxes).
• Within small cap, high quality has lagged as the rally has so far favored companies with lower ROE and higher leverage (and no dividends)—an expected dynamic during an early rebound period.
• However, the history of small-cap bull markets shows that higher-ROE companies tend to do better as the cycle matures. This intra-cycle rotation is particularly relevant because profits and earnings are beginning to show considerable variation and dispersion—creating an environment that should benefit active management approaches.
• We see a range of opportunities including companies which are helping their clients increase productivity, those benefitting from a sustained change in consumer’s leisure activities, and a variety of businesses participating in a robust housing market.

…About FIXED INCOME

WESTERN ASSET

The benefit of ballast

• We believe fixed income may play as vital a role as ever in portfolios. Due to its negative correlation to many risk assets, fixed income can provide portfolios with not only diversification, but also ballast.
• In our opinion, interest rates will remain largely range-bound. An inflation pick-up will likely prove transitory and not persistent.
• We see opportunity in high yield and bank loans. While we don’t see great room for capital appreciation in high-yield credit, we do see an attractive yield advantage versus other fixed income sectors, but we remain very selective. Historically, high-yield credit has done best when inflation is rising from below-average lows, which appears likely to be the case this year.
• We continue to position for a “reopening trade” and favor certain cyclical industries including airlines, cruise lines and select retail segments complemented by a higher-quality bias in less-cyclical subsectors providing ballast in our portfolios.
• Bank loans underperformed high yield meaningfully in 2020, so we view current spreads in that sector as fairly attractive.
• Also, we view emerging market debt as attractive, as global economies continue to reopen and recover.

FRANKLIN TEMPLETON FIXED INCOME

Walking the knife edge

• Active management will continue to play a critical role in walking the knife edge between improving funda­mentals and rich valuations.
• Limiting duration exposure remains a key element of our strategy.
• Fixed income investors should remain nimble and prepared to handle heightened volatility ahead.
• Central bankers might be underestimating how difficult it will be to deal with increased levels of inflation, especially if expectations become unmoored, and we therefore maintain a modestly positive view of US Treasury Inflation Protected Securities (TIPS).
• We continue to find risk assets more attractive than risk-free assets.
• We believe US high yield corporate bonds stand to benefit from an improving macro outlook, accelerating vaccine distribution and additional large-scale fiscal stimulus and remain constructive on the asset class.
• Floating-rate bank loans share these fundamental tailwinds and we believe the asset class is in the early stages of a rates-driven technical recovery, but believe discrimination is required.
• Fundamentals in the commercial real estate sector continue to be challenged and we believe downside risks outweigh upside potential and maintain a bearish outlook on CMBS.
• In the first two months of 2021, hard-currency EM debt recorded its worst start to the year in over 20 years on a total return basis. Local-currency EM debt performed similarly. This weakness is almost entirely due to the significant upward move in USTs since the beginning of the year and the asset class’s high sensitivity to core rates. Given the stronger economic outlook for the global economy and the reflationary benefits this will bring in terms of balance sheet repair for most EM countries, we retain our moderately bullish outlook for the asset class.

…About GLOBAL EQUITIES

TEMPLETON GLOBAL EQUITY

Double bubble, tails in trouble?

• Both absolute and relative valuations look expensive, so we cannot rely on further multiple expansion to drive gains. Nor are we counting on a protracted growth cycle to drive returns, given COVID-related impacts to supply chain efficiency, regulatory mandates, labor market flexibility, and structural challenges tied to debt and demographics.
• The current market environment highlights a “double bubble” in both valuation and credit risk that is keeping us generally cautious on both tails of the market – the expensive leaders and the lower quality laggards.
• Going forward, we expect the market to become more discriminate. In contrast to much of the past decade, we anticipate an environment where fundamentals and nuance begin to matter again, and where experience and expertise should ultimately pay off.

…About EMERGING MARKETS

FRANKLIN TEMPLETON EMERGING MARKETS EQUITY

World-leading companies from emerging markets

• From the height of the pandemic through to the current early stage of recovery, our conviction in the growing structural advantages of emerging markets, led by key Asian economies, has only strengthened.
• The idea of a world-leading EM company has become a reality over the last decade—a trend reinforced during the pandemic with examples of innovative, adaptable companies capitalizing on secular tailwinds.
• Taiwanese and South Korean semiconductor firms dominate the global industry with their strong manufacturing capabilities, especially in cutting-edge semiconductor chips.
• South Korean companies have also spearheaded the development of electric vehicle batteries, achieving worldwide penetration.
• In China, biotechnology firms are developing innovative treatments for cancer and other major diseases and have won the confidence of global pharmaceutical groups in licensing these new drugs.
• We believe we’ve passed the nadir in China–US relations, though tensions will remain elevated.

…About REAL ESTATE

CLARION PARTNERS

Real optimism for real estate

• Real estate values held up better than expected during the pandemic, thanks to massive government intervention, better overall real estate fundamentals, and several outperforming sectors such as industrial, life sciences and rental housing.
• Looking forward in the United States, we are quite optimistic about real estate’s growth prospects in 2021–2022 because of the fast vaccination rollout, additional fiscal stimulus and robust consumer demand.
• Real estate is a derivative of economic expansion, and all property sectors are likely to benefit from pent-up demand and a coming jobs boom.
• Historically, real estate as an asset class has shown to be able to hedge, at least partially, against inflation and rising interest rates because landlords generally can raise rents under improved economic conditions. Higher interest rates often link to better economic growth, which should lead to stronger demand for commercial space and higher income growth, offsetting the potential negative impact on financing costs.