Portfolio Manager Christopher Hugar comments for the ETF.com article “Solving the Income Riddle” by Olivier Ludwig.
We suggest investors divorce themselves from the idea that liabilities must be funded by income and income alone. Instead, it’s important to remember there are two ways to generate portfolio returns: either via income or capital gains. What’s more, it’s our view that the current environment has actually skewed return profiles toward the latter, at least in the near term.
Since 2009, quantitative easing has been the response of choice for deflation-fighting central bankers around the world. At its core, QE is specifically designed to suppress yields in an effort to push investors further out on the risk spectrum to reflate asset prices. By their very design, these programs tilt the scale away from income and toward capital gains. It’s suggested that investors shouldn’t “fight” central bankers, and pursuing yield alone in this environment feels a little bit like that.
With the Fed officially ending its QE program in 2014, the United States is now a tough environment for income-seekers and total return-seekers alike. Instead, we suggest investors look abroad. Consider the iShares MSCI EAFE Minimum Volatility ETF (EFAV | B-64), which yields just more than 3.0%. Roughly 40% of the fund is allocated to Japan and the eurozone.
Both are areas that have reasonable valuations, and central bankers are still aggressively pursuing QE, suggesting future gains will more than make up for the shortfall in any 5% yield bogey. As an added bonus, the product is even designed to have a lower-volatility profile—a favorable attribute for most income investors.
To read the entire article please click here.
Written by Portfolio Manager Matthew Krajna, The Select Managers Program Quarterly Review is issued to provide color to both strategy and individual fund performance and highlight any portfolio changes that have been made throughout the period.
If you have any questions or comments, or would like to discuss any of the NASMP strategies in further detail, please do not hesitate to contact our office at 716-633-3800 or e-mail: email@example.com
Nottingham Advisors’ President and Chief Investment Officer, Larry Whistler, was quoted in this weekend’s edition of Barron’s in Chris Dieterich’s article, “International-Focus ETFs Beat U.S. Counterparts.” In the article, Dieterich highlights the recent trend of investors pulling assets out of U.S. stock ETFs and putting assets into international stock ETFs. Nottingham’s own Larry Whistler summed up the shift with, “investors are starting to get reallocated.”
Not only does Dieterich highlight this shift, he also contends that it is actually warranted based on fundamentals. According to the author, while the S&P 500’s CAPE (cyclically adjusted price/earnings) ratio of 27 is well above its median of 16, the same metric for the rest of the developed world averages just 17, below its median of almost 23. In fact, we made a similar call back in February, urging investors to maintain a more global mandate amidst attractive international valuations and shifting economic dynamics.
Thus far, investors have not been disappointed as Dieterich highlights the performance of international equities through the first part of 2015. Investors with direct exposure to both Japan and Europe have been well rewarded as ETFs tracking the two regions have handily outperformed the +3.46% gained by SPDR’s S&P 500 ETF.
In the article, Larry also provides an option for those investors looking for a more diversified approach. He mentions one of Nottingham’s current holdings, the Powershares FTSE RAFI Developed Markets ex-US ETF (PXF), a fund that owns stocks from both Japan and Europe and weights them on the basis of certain fundamentals.
Only time will tell if 2015 serves as the year that international developed equities returned to favor, but Dieterich’s article has some compelling points. For those of you that are interested, the entire article can be found here. For those of you that still prefer the time-honored delivery method of paper print, the article is located on page 34 of the April 27th, 2015 edition.
Below please find the link to the Nottingham Advisors Chart Book. This is our internal chart book aimed at providing a wide variety of graphs and illustrations related to various domestic and international macroeconomic data points. As always, feedback on our publications is always welcome. If you have any questions or comments, please do not hesitate to contact our office.
Happy New Year everyone! From the entire Nottingham team, we hope that your 2015 is off to a great start. Here at Nottingham, the start of the new year brings about something that we believe is one of the most important parts of the investment management process: year-end reviews. As a firm that prides itself on both transparency and client service, we enjoy the opportunity to sit down and catch up with our clients, but also share with them how their portfolios performed. It’s also a good time for us to answer any questions that they may have.
Usually, the questions that we receive are as unique and diverse as the individuals that we serve, but occasionally we come across one that seems to be coming up in almost every review session.
Over the last month, one such question has popped up over and over again. It is also our experience that if several of our clients are asking it, the rest of them are probably thinking it. Fortunately for us, we started this blog to have an informal way to reach our clients and share our thoughts and, for that reason, we thought we’d take the time to tackle it in its own post.
Going into several portfolio review meetings or conversations, we’ve felt very upbeat about the portfolios and their performance. The portfolios posted another positive year and we were able to successfully navigate the markets in 2014, posting strong performance relative to our benchmarks. However, after sharing this news with clients, some have looked a little disappointed. They’ve often asked:
The S&P 500 did great this year…up +14%! Why didn’t my portfolio do as well?
Now, we don’t blame clients for anchoring their expectations to the S&P 500, which is more often than not the market proxy that they are most familiar with. However, as we’ve mentioned before, it is a less-than-ideal yardstick in measuring the performance of a global multi-asset class portfolio. The S&P 500 tracks the performance of large U.S. stocks, while the portfolios that we manage also include exposure to international stocks and bonds. Last year, while U.S. stocks did well, one of those other asset classes did not. The culprit? International stocks.
As you can see from the chart above, international equities diverged from U.S. equities in May and actually finished the year down -5%.
This divergence seems particularly striking this year. We’ve managed global portfolios for more than 10 years now and this question hasn’t come up nearly as much in the past. The reason for this has been the size of the divergence in 2014. The performance gap (19%) between international and domestic equities was the widest it’s been in 16 years! No wonder the impact on portfolio performance seems so apparent. Last year was a truly unique year.
In light of this, some clients may wonder why we even own international equities in the first place. In a nutshell, investors win when they use the broadest opportunity set. However, the truth of the matter is that this only works over longer periods of time. In any given year, this exposure can serve as either a drag or a boost on the performance of a portfolio. As we found this to be a hot topic for clients this year, we did a little more research to help them better understand the issue. We looked at performance between domestic and international equities over the last 44 years to review the distribution of outperformance. During that period, U.S. stocks outperformed 21 times and international stocks outperformed 23 times. It was practically a coin flip. With no reason to believe that the future will be different from the past, this means we are just as likely to be sitting here a year from now being thankful for that “global perspective.” In fact, with valuations attractive and the economic dynamics shifting, many market participants are starting to sing the praises of international equities once again.
In closing, remember that the year-to-year gyrations amongst asset classes can be noisy; the chart below proves as much. It highlights the annual performance of different asset classes as well as the performance of a diversified portfolio combining all of them (yellow box).
For any given asset class, there isn’t a discernible pattern. However, the diversified portfolio’s performance does appear to move in a consistent pattern. It doesn’t wildly jump from top to bottom. It stays in the middle, providing a smoother ride. Sure, that means that in years like 2014 when the S&P 500 ranks towards the top, a diversified portfolio might not match its performance (so called “diworsification”). However, over the long-run, you can bet it will make the ride a lot more comfortable.
So for those of you that have asked it and for those of you that have thought it, hopefully this helps answer the question.
Until Next Time,
Chris Hugar, CFA
We’ve pulled together a collection of recent charts, which we believe provide not only a concise recap of the major market moves defining 2014, but also some of our broad views heading into 2015. Click below to view the slide deck.
As always, please feel free to call or email us with any questions.
On December 5th, the Nottingham team volunteered at the Food 2 Families food drive. Food 2 Families is WGRZ 2 and Tops’ annual outdoor food drive that brings out the WNY community to support local families in need. The event raised over 100,000 pounds of food and benefits over 96,000 individuals served monthly by the Food Bank of Western New York. Click here to learn more about Food 2 Families.
Additionally, the Nottingham team got into the holiday spirit by purchasing gifts for the Gateway Longview Adopt-An-Angel Campaign. To learn more about the program, click here.
Let’s not mince words – for almost all investors, the S&P 500 Index is a terrible benchmark for their overall portfolio. Unfortunately, however, it tends to be the index that people are most familiar with and thus, the one they use. Each evening on the nightly news, the anchorman or anchorwoman will cast a broad summation of that day’s performance in the financial markets by citing the move in the S&P 500. For many, it’s the investment “barometer” that they see the most. This is likely a function of tradition as the S&P 500 Index was founded in 1957. At the time, large U.S. stocks made up the lion’s share of an investor’s assets and the performance of such was enough to pass judgment on the performance of one’s own portfolio. Over time, the S&P 500 became quite recognizable.
However, during the next 60 years, changes in the investment world have markedly changed an investor’s opportunity set. For example, an investor can now easily access a much larger variety of asset classes through the use of mutual funds or exchange-traded funds (ETFs). Despite this change in the make-up of investment portfolios, the S&P 500 and its strong recognition just stuck. In looking at it, the S&P 500 represents the largest 500 stocks in the United States. A quick analysis of that brief description alone is enough to realize that the index is clearly not built to measure the relative performance of a global portfolio allocated across multiple asset classes.
The index represents a collection of just stocks – not fixed income, not cash, and not alternatives. For everyone except maybe the most aggressive of investors, these are critical components of a well-diversified portfolio. Fixed income and cash provide downside protection in investors’ portfolios and provide the perfect counterbalance to much more volatile stock allocations. Moreover, alternatives have the ability to both mitigate risk and enhance returns.
Not only does the S&P 500 represent just a collection of stocks, it represents only stocks from the United States. Stocks from the rest of the world are completely excluded. As we’ve mentioned before, it is hugely important for investors to broaden their view and dedicate an allocation of their portfolio to stocks outside of the United States. Over the long haul, investors benefit from utilizing the most robust opportunity set. This is true because investments from different parts of the world are driven by different factors (growth rates, government policy, currency levels, valuations, economic activity, etc.).
Lastly, not only does the S&P represent a collection of stocks from just the United States, it represents only the largest stocks from the United States. While it is true that the overwhelming majority of the U.S. stock market is made up of the country’s largest companies, a still significant portion is made up of the companies that don’t make that cut – so called mid- and small-cap stocks. These smaller offerings provide a slightly different risk-return profile than their larger brethren and, therefore, they more often than not make it into many investors’ portfolios.
It’s pretty easy to see that the S&P 500 suffers from a broadness problem. It is much too narrowly focused to be used to correctly evaluate the performance of a well-diversified portfolio.
Let’s look at an example to see how using the S&P 500 as a yard stick may lead investors astray. Consider an aggressive investor with a portfolio made up entirely of global stocks. The chart below highlights annual performance over the past 15 years for domestic stocks (represented by the S&P 500 Index) and international stocks (represented by the MSCI ACWI Ex USA Index).
As you can see, in some years, domestic stocks outperform and in some years, international stocks outperform. If the hypothetical investor above uses the (narrowly focused) S&P 500 to evaluate performance, he or she will identify periods of both outperformance and underperformance based purely on the direction of foreign stocks. He or she may also attribute this performance to the overall management of the portfolio, when in reality it is purely a function of improper benchmarking. It is important to make sure that the benchmark is representative of the portfolio’s overall exposure to ensure an “apples-to-apples” comparison.
At Nottingham, we believe all investors should monitor and track the performance of their portfolios. If they’re managing it themselves, it provides some much needed self regulation. If they’re using an advisor (like us), it provides a high level of accountability. We’d simply advocate for making sure you are using the right “yard stick” to measure performance. We believe investors should view performance in the context of multiple assets classes, particularly domestic equities, international equities, fixed income, and cash. The weight afforded to each asset class should be derived from an individual’s specific risk tolerance. In many cases, those managing portfolios for themselves will find that an appropriate benchmark often introduces an unpleasant dose of reality as previously thought outperformance turns out to simply be the spoils of a bad benchmark. For those with advisors, it provides a much more fair and accurate view to evaluate their success or failure.
So the next time you see the S&P 500 quoted somewhere in the national news, be it in print or on television, just remember that it’s only part of the story…