Fund gains, global assets retreat amid heightened uncertainty

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Q1 2022 Multi-Asset Absolute Return Fund Q&A

• Global equities and fixed income posted losses due to geopolitical uncertainty, persistently high inflation, and rising rates.
• Non-directional strategies boosted performance, while directional strategies weighed on results, with the fund netting a positive return and outperforming Treasuries.
• We are refraining from a bearish position to equities given slightly bullish signals from our quantitative model, strong economic data, and the Fed’s aggressive efforts to tackle inflation.

What was the investment environment like during the first quarter of 2022?

It was a challenging quarter for global financial markets amid increasing headwinds. The Russian invasion of Ukraine, hawkish comments from the Federal Reserve, and persistently high inflation sent equity markets into a tailspin. Stocks rebounded slightly in March when the Fed lifted the federal funds rate to a range of 0.25% to 0.50%. Investors viewed this interest-rate hike as a positive step by the Fed to combat inflation. Peace talks between Ukraine and Russia also helped stocks move slightly higher, but not enough to erase earlier losses. The S&P 500 Index returned –4.60%. International stocks, as measured by the MSCI EAFE Index [ND], posted a return of –5.91%.

Bond markets also experienced significant declines over the quarter. Following the Fed’s rate hike in March, Fed policymakers penciled in six more increases by year-end, reduced their U.S. growth estimates for 2022, and raised their inflation expectations. The Fed’s median projections show their benchmark interest rate rising to a range of 2.50% to 2.75% by the end of 2022. This would be the highest level since 2008.

At times, yields on some shorter-term Treasuries, such as the 2-year note, edged above those of longer-term Treasuries of the same credit quality. This created a flat or inverted yield curve. By quarter-end, the yield on the 2-year Treasury note had climbed from 0.73% on December 31, 2021, to 2.28% on March 31, 2022. The yield on the benchmark 10-year Treasury note rose from 1.52% to 2.32% for the same period.

The Bloomberg U.S. Aggregate Bond Index, which is largely composed of Treasuries, highly rated corporate bonds, and mortgage-backed securities, returned –5.93% for the quarter.

Before we discuss performance, would you summarize the fund’s overall investment objective and strategy?

Putnam Multi-Asset Absolute Return Fund seeks a positive return exceeding the return of Treasury bills over a reasonable period of time, regardless of market conditions. The fund seeks to achieve risk-and-return characteristics by dynamically allocating assets using a combination of directional [or market sensitive] and nondirectional [or market neutral] strategies.

The directional portion of the portfolio consists of two components: a risk-balanced portfolio of stocks and bonds designed to efficiently capture long-term market returns and a dynamic asset allocation overlay to reflect tactical views. The overlay consists of tactical longs and shorts to equities, rates, credit, and commodities based on the portfolio management team’s expectations for each of these asset classes. The team manages both the composition and total level of risk, depending on market conditions and the prevailing opportunity set.

The non-directional portion of the portfolio consists of long/short market-neutral strategies that provide flexible, uncorrelated sources of alpha, a measure of outperformance of the stock market or of other risk assets.

How did the fund perform for the three months ended March 31, 2022?

The fund’s class Y shares returned 1.06%, outperforming the cash benchmark, the ICE BofA U.S. Treasury Bill Index, which posted a return of –0.03%.

What factors had the biggest influence on performance?

Overall, directional strategies weighed on performance in the first quarter. The equity portion of the risk-balanced portfolio experienced weakness, while tactical equity positioning led to a slight gain. The equity position ranged from modestly long to modestly short over the period before we eliminated the position at the end of March. The portfolio was net long equity risk overall, resulting in a negative contribution from directional equity exposure. The fixed income portion of the risk-balanced portfolio ended negative, while our modest tactical short position to interest-rate risk led to a small gain. We eliminated the position at the beginning of February. The portfolio was net long interest-rate risk overall, resulting in a negative contribution from directional interest-rate exposure. Tactical positions to credit and commodity risk had a minimal effect on performance.

Overall, non-directional strategies boosted performance. Equity selection alpha was the largest positive contributor, with our sector selection, quantitative emerging market equity, and forensic accounting long/short strategies adding value. Fixed income selection alpha lifted performance, owing to a strategy focused on structured mortgage credit. Alternative beta ended positive, driven by our volatility carry and cross-asset trend strategies (beta is a measure of systemic market risk, or the return from broad market exposure). Fixed income sector alpha was slightly additive, due to a strategy that shorts U.S. real yields.

How is the fund positioned at the start of the second quarter of 2022?

The fund is positioned close to a neutral stance entering the second quarter. Within our dynamic allocation overlay, we are modestly short credit risk and modestly long commodity risk. The portfolio did not have any tactical positions to equity risk and interest-rate risk at the end of the first quarter. Within the overall directional component, which includes the structural risk-balanced portfolio and the dynamic allocation overlay, we are net long equity risk, interest-rate risk, and commodity risk, and net short credit risk.

What is your outlook for the global economy?

The first few months of 2022 saw significant volatility. Rising inflation, supply chain disruptions, monetary tightening, and Russia’s invasion of Ukraine fueled sell-offs in stocks and bonds. Looking ahead, we expect volatility to persist and market sentiment to waver as these issues continue to plague markets with no clear resolutions in sight.

Our current outlook on equities is neutral. The stock market faces major headwinds, including a slowdown in earnings growth, rising interest rates, and geopolitical tensions in Ukraine. However, we are refraining from a bearish position given slightly bullish signals from our quantitative model, strong economic data, and the Fed’s aggressive efforts to tackle inflation.

In fixed income, our view on credit is modestly bearish. Assuming we have moved beyond the pandemic, it’s likely that the United States emerges very close to where it was in the credit cycle in late 2019 before the pandemic began. We also believe the high-yield index has reached peak credit quality and is not likely to improve from here. Our outlook on rate-sensitive fixed income is neutral. Yields have moved higher due to a significant and possibly overdone shift in Fed expectations, in our view. At the end of 2021, markets had priced in three interest-rate hikes for 2022. By quarter-end, the Fed had raised rates by a quarter percentage point, and markets had priced in six additional rate hikes for 2022. We expect a balanced distribution of outcomes moving forward. Our view with respect to commodities is slightly favorable. This position is supported by increasing and historically high roll yield, greater upside risks arising from the war in Ukraine, and rising demand for global crude oil given the reduction in Covid-19 restrictions.

Against this backdrop, we continue to have conviction in our investment strategies given our ability to adapt the portfolio to changing market conditions.