How are portfolios looking as of mid-year?
Despite continued sluggishness in global growth, conditions look to be improving behind the scenes as the quarters roll on. This has affected each asset class differently, causing total returns for the mutual fund portfolios to look relatively flat for the 2nd quarter—however, as the blended benchmarks suffered in the period—value-add was strongly positive (as it also was, to a lesser degree, for the Limited ETF and full ETF models). Your relationship manager can provide you with a copy of our quarterly asset allocation letter, which provides a recap of the quarter in terms of specific asset class performance and a review of the environment in 'snapshot' form. What follows is a quick summary.
Bond market expectations and prices have been largely dependent on sentiment surrounding the Federal Reserve's timing of rate increases. Assumptions for rate hikes appear to have been pushed back to a fairly even chance of either a September or December hike, although many are now focused on later rather than earlier (the postponement of this inevitable occurrence appears to be a persistent trend). As they often do, however, bond markets have moved on the likelihood in advance, resulting in a tough quarter for traditional intermediate- to longer- duration bonds. Our recommended positioning towards lower-duration fixed income, with a tilt toward corporate credit over government debt, resulted in a decent degree of outperformance versus the blended benchmarks—in fact, the corporate sleeve actually made money in the period. Foreign bonds came in slightly under water with negative returns, but holdings performed over a percent better than the developed market-heavy benchmark index—due to a shorter duration, tilt to emerging markets over developed and some hedged currency impact.
Equities are certainly no longer in the bargain basement, but conditions don't appear to be bubblesque, either. In a continued condition of economic repair, improving labor conditions and still-low interest rates (even with the assumed Fed move), conditions are accommodative and that generally bodes decently for stocks from a forward-looking basis. Earnings have struggled, of which a large part is due to extreme weakness in the energy sector; the other 9 non-energy industries are expected to achieve high single-digit EPS growth in 2015. Large-cap equity indexes gained just over a quarter-percent during the quarter, small-caps did a bit better than that, while mid-cap stocks languished in negative territory. Recommended positioning in large- and mid-cap equities outperformed the blended benchmark indexes, with a tilt toward 'growth' and less-cyclical 'quality,' while small-cap lagged a bit due to a more defensive positioning, which didn't allow as much participation in the higher-flying components of that market.
With the U.S. dollar leading the global rally in recent years, investors have turned increasingly toward international markets, which have led thus far in 2015 (after being so hated last year). Our recommended foreign equity positions outperformed the broader MSCI ACWI x-U.S. index (which includes emerging markets, per our change last year), with help from developed market smaller cap equities.
Real estate was a disappointment in the quarter, as U.S. REITs struggled in an environment of rising interest rates, which has always resulted in additional short-term volatility for the asset class (although longer-term results have historically moderated and improved in such an environment, when looked at from a full trailing year basis). However, losses in our recommended portfolios were tempered by allocations to foreign REITs, which represent roughly a fifth of the overall real estate portfolio. So, the value-add relative to the index came in positive.
Commodities, perhaps surprisingly, ended up as the best-performing asset of the second quarter—led by a 20% rebound in crude oil prices. Due to a lower concentration to energy than is held by the GSCI (roughly half to the sector as opposed to the two-thirds in the index), value-add was negative. While many don't expect the last decades' paradigm of scarcity and soaring prices, these remain a useful diversifier—especially if inflation begins to secretly creep up. It's also easy to forget how different the sub-components of the broad commodity indices are—the energy, industrial metals, precious metals and agricultural components tend to have very low correlations to each other over time. And commodities as a whole certainly have low correlations to other asset classes, which is why they've remained useful from a portfolio context.
Read our Weekly Review for July 6, 2015.
Read the previous Question of the Week for June 1, 2015.