Pressure Relief

Relief valves are one of the most important components of pressurized systems, controlling for excess strains that are caused by fluctuations in operating conditions. Their utility becomes especially apparent as conditions become less predictable. Macro policy and market dynamics can also create conditions where excesses emerge and should be addressed. Global inflation elicited aggressive monetary responses, which led to higher interest rates and, in turn, slowed growth. Meanwhile, higher short-term rates and elevated cost of capital have intensified demand for reliably profitable companies, embodied by the Magnificent 7, and money market funds, which experienced a 46% year-over-year increase in flows.

Today, we see two very common shortfalls in portfolio exposure: 1) high cash balances, that may provide excellent liquidity but often leave investors underinvested in risk assets during a favorable macro backdrop, and 2) burgeoning concentrated stock exposures, reflecting extremely narrow stock market leadership. We believe each of these pressures can be actively and efficiently relieved through tactful portfolio design and investment strategy.

In this edition of the Market Know-How, we consider how investors may relieve the pressures of excess cash and single stock concentration by:

Using exchange funds to swap large single stock positions for a diversified basket without triggering a capital gains tax.
Transitioning concentrated positions into liquid, diversified portfolios in a tax-efficient manner via tax-advantaged SMAs.
Extending duration to exploit hedging capacity and low costs of being early with potential Fed cuts on the horizon.

Source: Goldman Sachs Asset Management. As of March 15, 2024. The “Magnificent 7” refers to the seven technology companies driving S&P 500 returns: MSFT, AMZN, NVDA, META, TSLA, GOOG, and AAPL. “SMA” refers to Separately Managed Account. “Fed” refers to the Federal Reserve. Diversification does not protect an investor from market risk and does not ensure a profit. There is no guarantee that objectives will be met. Views and opinions are current as of March 15, 2024, and may be subject to change. They should not be construed as investment advice. Goldman Sachs does not provide accounting, tax, or legal advice. Please see additional disclosures at the end of this page.

Macro & Market Views

Not So Fast

Resilient growth across most developed market economies has created a wide dispersion of views. The aversion of a US recession in 2023 does not mean that an eventual recession was merely pushed back, in our view. We believe that risks to US growth have largely abated, and we see current levels of growth as commensurate with reaching the Fed’s inflation target. In Europe, the outlook for activity remains weak, though we expect a gradual recovery due in part to a pick-up in consumption. In Asia, while Japan entered a technical recession in 4Q, growth is likely to improve as wage increases continue and fiscal policy stays supportive, in our view.

Source: Goldman Sachs Global Investment Research and Goldman Sachs Asset Management. As of March 13, 2024. “We” refers to Goldman Sachs Asset Management. “Disinflation” refers to a reduction in the rate of inflation. “Fed’s inflation target” refers to Core PCE at 2.0% on a year-over-year basis. “A” refers to actual. “E” refers to expected. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this page. Past performance does not predict future returns and does not guarantee future results, which may vary.

Asset Class Outlook

It is no secret that a small number of US companies, though large in market capitalization, have outsized influence on the broader market today. Perhaps less apparent is a similar trend seen in Europe, with a small basket of quality growth compounders providing large contributions to index returns. While eventual monetary easing may result in broader participation, select corporate performance among top index constituents may continue to dominate market returns. Uncertain timing of rate cuts among global central banks and major elections may drive increasing volatility, which longer-duration fixed income, rather than cash, is well positioned for, in our view. Holding neutral strategic allocations across portfolios appears prudent in this environment.

Source: Goldman Sachs Global Investment Research and Goldman Sachs Asset Management. As of March 15, 2024. “We” refers to Goldman Sachs Asset Management. “Magnificent 7” refers to Apple, Microsoft, Meta, Amazon, Tesla, Nvidia, and Google. “GRANOLAS” refers to GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, L'Oreal, LVMH, AstraZeneca, SAP, and Sanofi. For illustrative purposes only. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this page. Past performance does not predict future returns and does not guarantee future results, which may vary.

Exchange Funds – Eggs in One Basket

Ebbs and Flows

Concentrated stock positions can originate from a variety of situations, such as early investment, executive compensation, and gifted stock. Owning large single stock positions can lead to substantial wealth creation, but these positions may also expose investors to concentration risks and large tax burdens upon liquidation. Considering that the median Russell 3000 stock is 3.3x more volatile than the index itself, we believe that diversification benefits are important in helping a given investor meet his/her objectives. One viable solution to alleviate these pain points is exchange funds. Exchange funds combine concentrated shares into a single investment pool, allowing investors to capture diversification benefits that come with owning a portfolio of securities.

Source: FactSet and Goldman Sachs Asset Management.

Exchange Funds: Scrap That Tax Drag

Taxing Situation

In addition to concentration risks, selling a low cost-basis, highly-appreciated stock to diversify a portfolio can quickly erode amassed wealth. Exchange funds facilitate a tax-free swap of public or private securities for shares in a partnership. No immediate capital gains tax is triggered upon entering the partnership, allowing for tax-deferred growth of an investor’s position. One consideration of exchange funds is that they typically must be held for a minimum of seven years. In the event of liquidation at year seven, however, we find that the after-tax value of an illustrative exchange fund holding is higher than that of an investor independently diversifying and selling his/her own basket.

Source: Goldman Sachs Asset Management.

As of March 13, 2024. Top Section Notes: Results shown are based off an analysis of Russell 3000 securities from 1986 through 2023. Bottom Section Notes: These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially. Diversification does not protect an investor from market risk and does not ensure a profit. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved. Goldman Sachs does not provide accounting, tax, or legal advice. Please see additional disclosures and assumptions at the end of this page. Past performance does not predict future returns and does not guarantee future results, which may vary.

Tax-Advantaged SMAs: Unlocking Captive Wealth

Managing Gains

Tax-advantaged SMAs are another powerful tool to manage concentrated stock positions and can be complimentary to exchange fund holdings. This solution provides unique benefits in that it doesn’t require qualified purchaser status, can be funded with a wide range of securities, and offers daily liquidity. As such, this strategy can unlock captive wealth in a tax-efficient manner while still achieving portfolio diversification. For example, diversifying a $10mn stock position over a three-year period through a tax-advantaged SMA, rather than immediately liquidating that position and redeploying the capital, results in an estimated ~$450k in tax savings, made possible through the realization of losses on other portfolio positions offsetting realized gains on the concentrated stock.

Source: Goldman Sachs Asset Management.

Tax-Advantaged SMAs: Competing Priorities

Balancing Act

Managing competing priorities can be a balancing act. Equity investors seeking to de-risk concentrated stock positions may need to consider the tradeoff between taxes and tracking error, or how closely portfolio returns differ from that of the benchmark. To limit the risk that a single stock’s poor performance will weigh on overall portfolio returns, an investor may seek to reduce tracking error, often at the expense of paying taxes. Tax-advantaged equity SMAs can help strike this balance, offering investors the unique ability to implement their personal preferences in pursuit of predictable tax obligations and greater portfolio balance.

Source: Goldman Sachs Asset Management.

As of March 13, 2024. Top Section Notes: Chart shows the estimated capital gains and taxes associated with an immediate liquidation of a $10mn single-stock position with a $2mn cost basis versus a 3-year transition to a diversified portfolio. Bottom Section Notes: These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved. Goldman Sachs does not provide accounting, tax, or legal advice. Please see additional disclosures and assumptions at the end of this page. Past performance does not predict future returns and does not guarantee future results, which may vary.

Duration Extension: Better Early Than Never

The Cost of Being Late

In addition to the favorable return asymmetry and capacity to hedge, the 10-Year US Treasury note has a very low cost of being early, in our view. Elevated cash yields have prompted many investors to extend duration only when they know that the Fed is cutting—a strategy that may be imprudent. Historically, 12-Month forward returns for the 10-Year US Treasury note have been highest beginning three months prior the first cut in a Fed cycle, and extending duration three months early has outperformed extending duration “on-time” or one month late by 6.4 and 8.0 pp, respectively. Furthermore, average 12-Month forward returns have been above 14% in every starting month from two-months prior to six-months prior to the first cut. We believe it is better to be early—whether by a little or a lot—than it is to be late.

Source: Barclays and Goldman Sachs Asset Management.

Duration Extension: Cash Out

ABC…Anything But Cash

A tactical cash tilt provided robust returns for portfolios in 2023, but as Fed cuts begin, we believe investors may consider incrementally moving out of money-market funds. Investors awaiting a specific signal, such as the dis-inversion of a yield curve, may be too late, as intermediate yields have historically declined materially by the time this dis-inversion occurs. The duration of a portfolio may be different for everyone, though we feel that at least short or intermediate duration is preferable to little or none. Investors have historically foregone 8 pp of upside on average when moving from cash to a 10-Year US Treasury note three months following the first Fed cut and 11 pp of upside on average when staying in cash in the long term.

Source: Barclays and Goldman Sachs Asset Management.

As of March 13, 2024. “Fed” refers to Federal Reserve. “Pp” refers to percentage points. “Fed cycle” refers to a period in which the Federal Reserve is raising and/or lowering the federal funds rate. Months of first cuts for prior six Fed cycles used are September 1984, June 1989, July 1995, January 2001, September 2007, and August 2019. Top Section Notes: Chart shows average twelve month forward return of the 10-Year US Treasury note in proximity to the first Fed cut in a cycle. Bottom Left Section Notes: “Dis-inversion” refers to the 10-Year less 2-Year US Treasury yield spread going from a negative to a positive value. Bottom Section Notes: Chart shows forward returns for three hypothetical portfolios in proximity to first Fed cut in a cycle. Past performance does not predict future returns and does not guarantee future results, which may vary.

See Glossary for definition of terms used in reference to Indices and Securities