April 6th, 2017
Dear Valued Clients & Friends:
First Quarter 2017 Market Review:
The first quarter of 2017 was full of political news as well as strengthening economic data globally. The latter point, in particular, confirms the strong possibility of upward inflationary pressure. This economic improvement caused asset classes with higher volatility (denoted as “Risk assets” in the graphic below) to outperform relative to bonds over the course of Q1, though bonds did rally during the last few weeks of the quarter.
Emerging market stocks (denoted as “EM equity”) significantly outperformed all other major asset classes, with a year-to-date return of 13% through March. This was due to expectations that stronger global economic growth would lead to better trade prospects for EM countries. International developed stock markets (DM equity) and the S&P 500 returned 8% and 6%, respectively, during Q1. This was indicative of, at least for the time being, political risks in the U.S. and Europe being outweighed by encouraging economic data. The Russell 2000 Index (Small cap), took a bit of a breather in the first quarter after a very strong rally through most of 2016, returning just 2% through March.
Despite the Fed raising rates in March, most bond categories experienced a positive return in the quarter. High yield bonds were the winner, up 3% for the quarter. The yield on the 10-year Treasury finished the quarter at 2.40%, a bit lower than the starting yield of 2.45%.
Data provided by J.P. Morgan as of 3/31/17.
The Beginning of Reversion to the Mean?:
The 1990’s rally in U.S. large caps was followed by over a decade (2000-2012) of around a 0% cumulative return for the S&P 500. Remember the financial media talking about the “lost decade”? During that lost decade, certain asset classes like Emerging Markets stocks and REIT’s rose well over 100%. Unfortunately, the lost decade is a lost memory for many investors.
As we wrote in our January 2016 Year-in-Review client letter, it has been challenging to stay diversified since 2012, as U.S. large caps have outperformed nearly every well-diversified portfolio approach. Investors have been wondering: does diversification still makes sense? We think this is a perfectly natural question to ask. Through February 2017, the S&P 500 had outperformed an asset allocation portfolio* by 55% cumulatively over the previous five years. Did I miss the boat? Should I add more to U.S. large caps now? Study after study has shown that investors have a bias to want to own more of what has been doing well, and the longer a certain asset class outperforms, the stronger this bias becomes. Instead, investors should be asking a different question: after periods of asset allocation underperformance vs. the S&P 500, what has happened next? Well…I’m glad you asked. As the below chart shows, when the S&P 500 has outperformed a diversified portfolio over rolling five-year periods, on average this has resulted in a following five-year period where asset allocation portfolios significantly outperform the S&P 500. What investors can take away from this analysis is that it makes a strong case for asset allocation, as relative asset class underperformance or outperformance (as has been the case of the S&P 500) typically reverts to the mean:
*Data provided by J.P. Morgan as of 2/28/17. The chart looks at rolling five-year periods over a 25-year time horizon. The Asset Allocation portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE Index, 5% in the MSCI Emerging Markets Equity Index, 25% in the Barclays U.S. Aggregate Index, 5% in the Barclays 1-3 Month Treasury, 5% in the Barclays Global High Yield Index, 5% in the Bloomberg Commodity Index, and 5% in the NAREIT Equity REIT Index.”
After a strong finish to 2016 and continued market cooperation through most of 2017 thus far, we made a smaller number of incremental portfolio changes in the first quarter of 2017. We feel we remain sufficiently well positioned for brief periods of volatility that may pop up throughout the year, but globally, the general outlook is for gradually improving economies for the balance of 2017. The primary portfolio adjustment in the first quarter is described below:
- In the middle of February, Compass Ion Advisors’ Investment Committee elected to, for the time being, remove the Equity Beta (pure market exposure) sleeve from within the Alternative Investments portion of client portfolios. The fund we removed, run by Eaton Vance, was a global beta fund that could raise cash levels in portfolios during periods of extreme crisis. We did not remove them because of performance reasons but because we have reallocated from pure Equity Beta to a different Core Equity strategy within Alternative Investments. The new strategy we added, in addition to providing U.S. stock beta exposure, also incorporates an equivalent amount of exposure to risk mitigation strategies at all times. In summary, it is designed to provide “crisis alpha” through the trend-following benefits of managed futures. Specifically, as our long-term clients recall, managed futures strategies have historically been able to provide pronounced gains in periods of prolonged market stress (such as 2008). Yet, during the calm times, investors will still receive the return of the S&P 500 plus or minus the return from the exposure to a more muted managed futures component as well. The strategy we have chosen to utilize for this approach is the Aspen Portfolio Strategy Fund.
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This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third party sources and is believed to be reliable. This presentation may not be construed as investment advice and does not give investment recommendations.
The securities presented may not be representative of the current or future investments for Compass Ion clients. You should not assume that investments in the securities identified in this presentation were or will be profitable.
Additional information, including advisory fees and expenses, is provided on Compass Ion’s Form ADV Part 2. As with any investment strategy, there is potential for profit as well as the possibility of loss. Compass Ion does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. The investment return and principal value of an investment will fluctuate so that an investor’s portfolio may be worth more or less than its original cost at any given time. The underlying holdings of any presented portfolio are not federally or FDIC-insured and are not deposits or obligations of, or guaranteed by, any financial institution. Past performance is not a guarantee of future results.
Sources: Tamarac, J.P. Morgan