Mercer advises institutions with more than $16 trillion in assets. Here’s what its top investment strategist is telling the world’s biggest investors.

Rich Nuzum is Mercer’s global chief investment strategist

Rich Nuzum is Mercer’s global chief investment strategist, advising institutional investors with more than $16 trillion in assets (yes, trillions with a “T”) on where to put money, what to be worried about, and who to trust with their precious capital.

He spoke to B-17 about the private credit boom, evaluating asset managers, and being ready for the next crisis. This interview has been edited for brevity and clarity.

What’s on the minds of your biggest institutional clients?

Every client is different, and we tend to come to things with a blank sheet of paper, but with that said, I think there are three main themes. One is to grab the higher real and nominal yields that are now available while they’re still available. As we sit here today, we can get 3.82% nominal in a 10-year treasury; we can lock in a real yield of about 2.15%. That’s down from what was available last October, but it’s still a lot better than most of our recent lived history.

So grabbing those yields is a focus of a lot of investors. You can do that through private credit. You can do that through infrastructure debt. You can do that through real-estate debt. You can customize the duration of what you’re investing in to match your objectives and how much liquidity risk you’re taking. So that’s very attractive and what’s driving the interest in private credit is.

We’ll get back to private credit, but what are the other two items on the minds of big institutions?

So one is diversifying their portfolios, and that’s driving increased interest in all the liquid alternatives, and then also in hedge funds, but not for all clients. There is continued strong interest in hedge funds from a subset of asset owners, whereas I’d say the interest in private credit, private equity, real estate, and infrastructure is more uniform across investors.

The second is getting ready for the next crisis, trying to make sure governance is ready to be opportunistic. A quick walkthrough of recent history shows that in the global financial crisis, you could get great private equity portfolios of 60 cents on the dollar for about three to six months and great deals on distressed debt for about three to six months. For high-yield debt in the COVID drawdown, it was about three weeks. In the gilts crisis, it was about three days. So the opportunity to be opportunistic seems to be shrinking as we have these crises, and having your governance ready —at least to rebalance, but ideally to be opportunistic — is a focus for a lot of institutional owners.

There’s a sense that we haven’t had a real crisis in a long time. The COVID drawdown was actually short-lived. We, collectively as a society, threw so much monetary and fiscal stimulus at it. While the virus was horrible, the economy didn’t come to a halt, at least in developed markets. The policy response worked.

People are trying to get their governance ready to be opportunistic fast but also ready for, say, a three-year period when the stock market’s down 45%.

Private credit has been the flavor of the month for roughly a year now, and it seems like institutions can’t get enough. Do you have any worries about the space?

We were a lot more worried about the possible impact of a widespread crisis on the private credit sub-asset classes last October than we are today. When you go back to the Greenwich Economic Forum last fall, about half the people that got onstage were telling us that the US 10-year yield was going to go to 7.5%, the US government budget deficit and structural deficits weren’t sustainable, that the US dollar would lose its role as a global reserve currency — and this was during a week when Speaker McCarthy found a way to keep the government open, but at the cost of the speakership. We were talking about trying to get inflation under control globally, and it wasn’t clear that the monetary authorities could do that. The consensus wisdom was that to do that, they’d have to put us into recession with significant unemployment, so then you lose consumer confidence.

And today, we’ve got stocks at all-time highs. We’ve got bond yields well-behaved. We’ve got the Fed Chairman going to Jackson Hole and saying, ‘Okay, it’s time to cut.’ So the prospect of an immediate crisis is a lot more relaxed, so the idea that these asset classes are going to get challenged and stressed in a way that some of them have never been before is a bit more remote.

Also, the regulators — there’s always the possibility of regulatory intervention disrupting an asset class. My sense is they were more concerned about the innovation in private credit a year ago, and they seem to have collectively gotten more comfortable with the narrow banking thesis that having banks intermediate was probably less good for the financial system than having long-term institutional investors with sophisticated intermediaries intermediate these things.

Because if there’s a loss somewhere — if we’re collectively making a mistake and it turns out to be more risky than we think, with bigger defaults and less repayments — those losses, most of them, are going to hit well-diversified, long-term oriented investors and they’ll impact those investors’ ability to achieve their investment objective, but it’s not banks with retail depositors suddenly with insolvency.

I’m constantly talking to fund managers, and they want to know how to stand out to consultants like Mercer beyond just a strong track record. What do you look for?

Our manager research and selection process is forward-looking, and that’s really helpful. What we’re looking for is a competitive advantage in four areas.

One is idea generation. What do you think is going to drive securities prices going forward in your area of interest? Two, portfolio construction. How do you build a portfolio that’s exposed to where you have a view and not exposed to other risk factors where you don’t? Three, implementation. How do you trade the portfolio without giving back the value of your insights and trading costs? And then business management. How do you maintain and enhance your competitive advantage on the first three?

In our research process, we’re meeting with all the smart, well-resourced people in a given area. Eight of them are going to sound the same and be doing the same things, and then the ninth and 10th that we meet with will have an edge, a competitive edge, on idea generation, portfolio construction, implementation. It could be because they’re using AI in a new way or they got some new data.

What was a competitive edge three years ago is not a competitive edge today.