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A Letter from Our CIO: Responding to Markets and Investor Concerns

CIO, Systematic Equity

In the first half of the year, global markets were turned upside down. The start of the Russia-Ukraine War was certainly a triggering event, but when that conflict began expectations around slowing global growth had already begun permeating markets. Rising inflation and energy costs, coupled with hawkish central bank actions, weighed heavily on market sentiment and contributed to substantial market volatility. As a result, we saw record declines in most major market segments.

Our business, like most, was impacted by market moves and risk-off buying behavior. Both retail and institutional investors moved into more defensive exposures. Our equity indexing book had around $2.1T in assets as of the end of the second quarter, marking a 21% reduction in AUM since the start of the year (when we posted record AUM figures).

While this reduction may appear unsettling, much of the decline in AUM was driven by market moves versus client outflows. We have had around $59B in outflows since the start of the year, and much of that was due to a single strategic client undergoing an asset reallocation. I remain optimistic around the potential future growth prospects within our indexing franchise, as many of our clients have relatively long-term investment horizons and utilize strategic asset allocations that will always carry an exposure to public equities.

We are also fortunate to be able to offer clients a wide range of beta exposures and vehicles, including ETFs, that can be implemented and utilized across different market regimes for tactical or long-term asset allocation. We are increasingly seeing institutional clients leverage ETFs because of their enhanced transparency and liquidity. In two recent thought leadership pieces, we discussed ways in which institutional clients can implement different third-party index and proprietary solutions to address volatility in their index equity exposures.

Regarding more near-term concerns, we fielded a number of queries about the impact of Russian sanctions. While all equity index vendors have deleted Russian securities at a price of 0.00 (which is how these securities continue to be valued in portfolios), we await the opportunity for the market to be accessible again so that we might attempt to realize some value on behalf of our clients. We are also working on converting our Russian depositary receipts into local shares (i.e., where mandated to do so by a Russian Law that was enacted in April in response to the sanctions). We continue to monitor this fluid situation daily.

As discussed in prior messages, some longer-term investor concerns have shifted toward better understanding the risk that climate change poses in an equity portfolio. To address such concerns, we continue to utilize our low-carbon optimization framework in both bespoke portfolios, as well as in our flagship pooled Sustainable Climate Fund solution. Also, to assist our clients in meeting their near- and long-term net zero targets, we recently undertook a research project that looks at ways to implement a year-over-year self-decarbonization scheme. For more on this topic, I highly recommend a recent piece by our research team on data nuances within climate portfolios.

Looking to the remainder of the year, our research team will be focused on how we can best address changes in climate science that will be included in the upcoming final Intergovernmental Policy on Climate Change (IPCC) report (due to be released in September). We’ve been in the process of vetting, assessing, and onboarding various forward-looking climate and ESG metrics, with intention of either incorporating them into a portfolio via our flexible optimization framework or simply report on them.

Our research and portfolio management team has also been focused on developing momentum signals that can be incorporated into the value-add trading strategies used during index rebalances. In addition, a joint research project with our Active Quantitative Equity team is seeking to reassess our proprietary factor definitions. I look forward to sharing these research findings and solutions with you in the coming months, and to developing other solutions that will meet our clients’ evolving needs.

Closing Thoughts

In closing, I’d like to step away from the markets for a moment to acknowledge the immeasurable human impact of the ongoing conflict in Ukraine. Our thoughts go out to the Ukrainian people, and to all those impacted by the war, including our State Street colleagues in Poland.

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