Within fixed income, we have maintained a portfolio of short- and medium-duration high-quality credits that can produce competitive returns across many different inflationary regimes. We are avoiding longer-duration credits (those longer than 10 years), as we are being adequately compensated in short- and medium-duration assets.

The larger the federal budget deficit and debt level, the greater the bond risk premium is likely to be, which suggests higher yields on Treasuries. Staying with short- and medium-duration credits will position our portfolio to capture potential rate increases more quickly while helping to minimize rising yields’ price impact on longer-duration fixed income.¹ We are also invested in securities that we expect to be resilient in an uncertain future.

If higher interest rates are the most tangible near-term impact of higher inflation and increasing debt and deficit levels, our meaningful allocation to long-term high-quality public equities with pricing power and private equity is the best portfolio solution. Adding alternative assets to a portfolio can provide much-needed return enhancement and inflation protection as well as diversify exposure. Over the past few years, we have been focused on adding allocations to several “independent return” strategies that seek to produce equity-like returns with low beta² (and correlation) to equity markets. We have also added exposure to private investments where we seek to capitalize on market inefficiencies and an illiquidity premium to generate greater returns than those in public markets. Within private markets, we have exposure to real asset investments that can hedge against inflation.

While high market valuations are associated with an increased probability of a market correction, they do not provide information about when a market correction will occur. We are highly attuned to market valuations, but we do not use them to move in and out of the stock market.

Additionally, we do not own the index. Our public equity portfolio does not look like the S&P 500, in that it is higher quality (that is, fundamentals are better) and more diversified (with high-quality companies outside of the U.S.) and has a smaller market capitalization. Our public equity portfolio is more correlated with the smaller-capitalization S&P 500 Equal Weighted Index than the market cap-weighted S&P 500. We are comfortable with this positioning long term, as today the S&P 500 trades at a 27% premium to its equal-weighted version and sits 1.6 standard deviations⁶ above its historical average valuation (compared with the Equal Weighted Index trading at its historical average).

Historically, the Equal Weighted Index has outperformed the market cap index during roughly 80% of rolling 10-year periods, by an average of 2 percentage points. As a result, though our positioning detracted from relative results in 2024, we believe that our more diversified approach and smaller-cap bias (relative to the S&P 500) will be rewarded over a full market cycle, and we remain committed to our long-term approach.

Now is the time for active management, as active managers have tended to outperform in periods of widening market breadth. With market breadth at all-time lows, we expect to experience a broadening of performance across more companies, and we are positioned to respond. Our active management strategies tend to focus on high-quality companies with pricing power that:

• Sell essential, price-inelastic products and services or “products and services with strong pricing power”
• Exhibit strong free cash flow growth
• Have strong management teams who are exceptional capital allocators

While our public equity portfolio is diversified and performing well fundamentally, it is not immune to a market correction. This is why we are also diversified across asset classes, including the following:

• We look to fixed income in order to provide liquidity, stability, and yield in our portfolio.
• We believe increasing our allocations to alternatives can generate a return premium over public market equivalents over the long term while also providing portfolio diversification.
• We also believe that the current environment will provide additional tailwind for private markets in particular.
• With the Trump administration, we expect a trend toward deregulation, including reduced barriers for mergers and acquisitions activity. We think this bodes well for private equity (PE), particularly since PE valuations remain below 2019 to 2022 levels.

Bottom-up investing is one of the best tools for mitigating geopolitical and regulatory risks in a portfolio. At the portfolio level, all investment strategies must compete for capital against all other investments. This helps us manage the risks embedded in a traditional asset allocation process that forces allocations to a variety of asset classes, including some that may not be attractive.

We are positioned today with de minimis exposure to Russian, Chinese, and Middle Eastern equities. We are underweight “big tech,” or the Magnificent Seven, relative to the S&P 500, although we do have some exposure. Where we are invested, our managers have put tremendous effort into understanding potential ramifications of antitrust lawsuits.

Finally, the Trump administration has historically been less supportive of big tech and more supportive of smaller companies, including startups. We think private companies focused on AI, digital assets, and defense, among other sectors, will likely see more support from the new administration.

Policy matters, but its investment impact is difficult to predict and often overestimated. We will continue to invest with an eye toward potential regulatory risks and opportunities, but what is most critical is that we prepare our portfolio to be resilient in a variety of future permutations of world events.

We are believers in AI’s long-term opportunity, but we are also keenly aware of the course of technological waves and valuations. Our best assessment of AI today is that the market may be overestimating its near-term impact but underestimating the long-term opportunity. Hyperscalers⁷ in aggregate have spent around $175 billion in capital expenditures over the past four quarters, but they are estimated to generate only $20 billion to $25 billion in AI revenue this year. This suggests AI applications may not generate a net positive return on investment on infrastructure buildout for some time.

However, this type of investment is typical in technological waves and eventually results in an ecosystem that allows the technology to be incorporated into more workflows and be accessible to a wider group of adopters. Accordingly, we see AI as both an opportunity and a risk. We have meaningful exposure to AI companies within our portfolio and believe that if AI changes the world as much as many expect, our portfolio should benefit from this paradigm shift.

We segment our AI exposure into four main categories:

• Tech hardware, which includes semiconductor companies such as TSMC, ASML, and Nvidia. These companies play valuable roles in the supply chain of semiconductors required to use AI.
• Tech AI infrastructure, which includes companies developing large language models (LLMs), such as Alphabet, Meta, OpenAI, and Mistral. LLMs require major investment to train, and therefore, several “big tech” companies have a funding advantage.
• Tech AI software, which includes AI applications accessed through our venture capital portfolio, such as companies like ElevenLabs, OptimizerAI, and Anysphere.
• Companies that seek to leverage AI to streamline their processes, enhance their products and/or services, and increase their productivity. We believe that companies that are not thinking about how to leverage the technology risk being left behind.

Within public equities, in particular, our investment approach – which calls for investing in high-quality companies with sustainable business models and pricing power run by strong management teams – can provide an additional layer of protection against the risks of AI.

As we have always said, volatility is our friend. We view an increase in volatility as an opportunity to capitalize on short-term discrepancies between value and price – we just need to position ourselves to take advantage of those mispricings when they occur.

We have a slight overweight to cash in our current portfolio, and our managers are holding cash balances (a result of their bottom-up investment style) above historical averages, both of which can be leveraged to pursue attractive opportunities at the appropriate time. Cash also helps to serve as a ballast during the beginnings of any downturn before we can put it to work buying great investments “on sale.”

The most important protection against volatility is focusing on the long term. The preservation and growth of overall portfolio value requires patience and a willingness to benefit from underlying portfolio diversification. Some portfolio components are designed to outperform in certain environments, and other strategies will do better in others. This is by design. All of the components are thoughtfully constructed to preserve and grow capital over the long term at the portfolio level.

Preserving and growing wealth is about time in the market, not timing the market. Staying invested is critical. Volatility will occur from time to time, but dramatically moving around one’s asset allocation to try to time the market is a recipe for long-term capital impairment.