Reflections on 2016 & Beyond
A question one should ask oneself periodically is: “how is my portfolio getting along?”. Trying to get to the bottom of this seemingly simple question often leads to more questions than answers. The answer is generally a combination of fund selection, asset allocation and fees.
For MASECO, let’s reflect on asset allocation first. On the equity side, we currently tilt portfolios away from US equity into a higher allocation towards Emerging Markets. This is a long-term belief that we believe is designed to improve both returns as well as diversification (given the US otherwise represents about 54% of global equity markets). This idea had very little performance impact last year, as both equity regions produced only marginally different returns over the 12 months (comparing MSCI EM with S&P 500 in USD)1.
We also made small allocations into commodities and REITs (Real Estate Investment Trusts) to get some diversification within our allocation into growth (high risk) assets. Last year, the impact of this measure was mixed, as REITs (S&P Global REITs in USD) underperformed Global Equity markets (MSCI ACWI in USD), but our commodity allocation paid off, as diversified commodities with an 11.8% return (Bloomberg Commodities in USD) beat the 7.9% return from Global Equities1.
Focussing more intricately, we believe in the long-term benefit of pursuing select equity return premia like value. In the US, value stocks appreciated by 18.4%, beating the S&P 500 by 6.4%. Outside of the US, value stocks gained 7.4% in USD terms, out-performing the broader non-US equity market by 4.6%1.
We also favour investing into smaller companies and were again handily rewarded both in the US as well as in the rest of the developed world. While the MSCI World ex US Small Cap index outperformed the MSCI World ex USA index by 1.6% in 2016, the Russell 2000 index beat the S&P 500 index by a whopping 9.3%, delivering a total return of 21.3%1.
Switching to the fixed income side, again results were positive. We captured a maturity return premium, as short-term global government bonds (Citi WGBI 1-5y hedged) improved on US cash returns by more than 1.2%. The return premium expected from exposure to credit risk also contributed positively, as performance of short-term credit (BoAML US Corporate 1-5y) beat short term government debt (BoAML US Treasury 1-5y) by 1.3%. Selectively hedging part of our fixed income allocation fared even better1.
Last, but definitely not least, our alternative fixed income strategies, which also included exposure into emerging debt markets, had the biggest positive impact on the final calendar year performance numbers of our global fixed income model portfolios. The Templeton Global Bond Fund and the Templeton Global Total Return Fund returned 6.6% and 8.7% respectively1.
Let’s now also look at the performance impact of manager selection. Before we do, it is good to know that every year S&P publish their S&P Indices Versus Active Funds (SPIVA) Scorecards, comparing active fund managers versus their respective benchmark indices over a one, three, five and ten-year time frame. As S&P published in their bi-annual report from the summer of 2016, active managers continue to show poor results. Over a 1-year period2:
• 81% of actively managed Large Cap equity funds underperformed their benchmarks
• 77% of actively managed Large Cap Value equity funds underperformed their benchmarks
• 91% of actively managed Small Cap equity funds underperformed their benchmarks
• 55% of actively managed International equity funds underperformed their benchmarks
• 42% of actively managed Emerging Market equity funds underperformed their benchmarks
• 64% of actively managed Government Intermediate Bond funds underperformed their benchmarks
• 60% of actively managed Investment Grade Short Term bond funds underperformed their benchmarks
So on average most active managers failed to outperform the respective S&P indices. To be successful at improving returns, an investor therefore has to rely on picking those managers that do.
At MASECO, we have a strong preference for a special breed of active managers: those that can back up their investment beliefs with strong academic evidence, and attempt to generate returns in a systematic manner. The obvious question begs, if selecting from that subset of active managers provided a better return outcome for our clients versus the average effect captured by the SPIVA reports – what is the result?
We looked at our current positions in our EUR, USD and GBP Core model portfolios to find the answer. Any funds that do not attempt to beat their benchmark (e.g. passive benchmark trackers) were excluded. Looking at their performance for the calendar year 2016 compared to their respective fund benchmarks, 34 out of 38 investments, or ~90%, produced better results after all management fees and cost3.
What’s most important for us, however, are long-term results, because those also matter most for our clients. The longest performance period we can analyse are the 8 years since MASECO was founded (1st January 2009). So far the odds were stacked in our client’s favour, as from all the investments that have a sufficiently long track record, 21 out of 28, or 75%, beat their benchmarks3.
To summarize, let me end by looking at the consequence of all performance drivers combined. Last year 74% of our US, EU and GB model portfolios beat their respective benchmarks, after assumed fees of 1% pa. Gross of fees, that number goes up to 95%. Critically, when looking at the equivalent, long-term hypothetical track records since the inception of MASECO, the picture looks very similar: net of fees, 85% of all model portfolios delivered the desired outcome, or gross of fees, the number moves up to 100%3.
1 – Morningstar
2 – Standard & Poors
3 – MASECO Private Wealth