DWM 1Q15 Market Commentary

brett-blogBoring. That’s what we could call our investment style, but we like it that way. In baseball terms, which seems appropriate given Opening Day 2015 is upon us, we are all about cranking out consistent singles and doubles; we are not interested in striking out going for that home run. We use low cost securities that give us broad diversified exposure to many asset categories. This disciplined approach will take away the volatility found in speculative investors’ portfolios, provide more stable returns, and help one achieve their long term goals. It isn’t flashy, but it’s a tried and tested process that works.

As part of our philosophy, we believe:

  1. Traditional capital markets (like equities and fixed income) work and generally price securities fairly. (Which is why we use generally passive instruments in our equity and fixed income models.)
  2. Diversification is key. Comprehensive, global asset allocation can neutralize the risks specific to individual securities. (Which is why we don’t utilize individual stocks.)
  3. Risk & Return are related. The compensation for taking on increased levels of risk is the potential to earn greater returns.
  4. Portfolio Structure explains performance. The asset classes that comprise a portfolio and the risk levels of those asset classes are also responsible for most of the variability of portfolio returns.
  5. We can increase returns and minimize downside through portfolio design using our special blend of both passive (found generally within our equity and fixed income models) and active (found generally in our alternatives model) investment styles.

As one can see above, our approach involves the understanding of asset allocation – a portfolio’s mix of equities, fixed income, alternatives, and cash – and what mix is appropriate for the client based on their risk tolerance and other unique factors.

Given all above, to understand performance is to understand how the asset classes within your portfolio are doing. Hence, we find it prudent to incorporate a discussion on how each of the major asset categories (equities, fixed income, and alts) are doing within these market commentaries. The same way a baseball manager may look up and down his line-up, seeing what is working, what isn’t, and why? That being said, let’s take a closer look into how each asset class fared in the latest quarter:

Equities: The MSCI ACWI Investable Market Index, a benchmark capturing ~99% of the global equity markets, registered +2.3% for the quarter. International (+4.9%), small cap (+4.3%), and mid cap (+5.3%) outperformed large cap (+1.6%) this quarter. The S&P500/large cap has outperformed the other styles for a good while now, and as we have said many times before: expect reversion to the mean. Well, it’s happening. Traders and investors are noticing that the S&P500 is getting a little expensive, trading at 16.7 times forward 12 months forecasted earnings which is above the 10 year average of 14.1. The economies overseas may not be as strong as here in the US, but most are modestly improving and frankly international markets are cheap. Also there are many multinational companies that lie within the large cap space – with the dollar surging, the profits of these big boys are decreased.

Fixed Income: Most bond investments had modest price increases with the Barclays US Aggregate Bond Index up 1.6%. However, international markets didn’t fare as well as shown by the Barclays Global Aggregate Bond Index being down 1.9%. So what’s going on? Outside of the US, many central banks around the world are cranking up the easy money policies, bringing yields on overseas bonds down, in some cases to negative yields. US bond yields are very low but are higher than their international counterparts, so foreign buyers continue to buy our US bonds, thus pushing prices up. In fact, US Government bonds rose for the 5th straight quarter in a row as the yield on the US 10-yr Treasury Note fell from 2.17% at end of 2014 to 1.93%, confounding many traders that expected yields to rise in response to possible higher interest rates and improving signs in the US economy. We do think yields on the US government bonds should rise soon as the Fed has indicated an interest rate increase occurring in the near future. They’ve also made many traders happy when they said the cycle upward, once started, will be a slow one.

Alternatives: Nice start for the Credit Suisse Liquid Alternative Beta Index (+2.8%) and many of the liquid alternatives we follow. Of course, oil was down big, however if your current exposure to commodities was via a managed futures vehicle, you were most likely “short”. Which means that with commodities going down last quarter, you most likely profited. In fact, the AQR Managed Futures Fund which we follow was up 8.5% this quarter. Other notable alternatives include: 1) real estate, up +5.4%, as represented by the SPDR Dow Jones Global Real Estate Fund, and 2) a global tactical fund called John Hancock Global Absolute Return, which was up 3.7% on the quarter and invests by tactically trading (going long and short) equities, bonds, and currencies (e.g. betting the US dollar versus the Euro).

In our last quarterly commentary, we said to expect more volatility and indeed that’s what happened in 1Q15, as evidenced by the S&P500 closing up or down more than 1% nineteen times. But by continuing with our “boring” style, the expected increased volatility in equities won’t significantly affect our batting line-up. In fact, our ball club is built to endure whatever is thrown at it. By having diversified players (i.e. investment styles like equities, fixed income, and alternatives) focused on things that can be controlled, we’re confident this team can bring home the championship!

Brett M. Detterbeck, CFA, CFP®, AIF®