2016 Q4 Investment Report Commentary
Market Update: Recalculating…
When heading to a destination, many turn to Google Maps or other GPS apps for turn-by-turn directions. You have advance notice of turns, left-hand exits, and even accidents or road construction. Should you miss a turn, they recalculate your journey without judgment. No such reliable guide exists for investors, as the future of markets is impossible to map. Prudent investing therefore becomes an exercise in “recalculating” without a map, and building portfolios must take this reality into account. Confounding expectations are a regular feature of the markets and the fourth quarter was no exception. Clearly, the most surprising event was the election of Donald Trump, defying most experts’ predictions. This surprise poses many implications going forward, but the biggest impact on markets to date has been the rapid rise in interest rates. The move actually began before the election, as the 10-year Treasury moved from 1.6% on September 30 to 1.9% on Election Day. To be sure, the subsequent move to 2.5% by year-end was more impressive as investors fully embraced an expected pick-up in growth and inflation (see chart below). This recognition coincided with the increased likelihood of a Fed rate hike, which happened in December.
These altered expectations and the Fed’s rate increase led the market to cast aside its preoccupation with the economic stagnation thesis and embrace higher rates, a shift repeatedly postponed over the last three years. The move in interest rates led to strong relative returns for Daintree clients’ fixed income portfolios, performance that resulted from sound positioning and resolute patience.
Daintree’s process considers the various expectations built into asset prices, but long-term valuation is a key component that drives occasional tactical changes in client portfolios. Valuation typically gives us a better fix on whether markets are priced for perfection or imply a dire view. Currently, the optimism in stocks does have a basis in economic reality, but stocks are not altogether cheap. Rather, the U.S. appears a bit rich while Europe and Emerging Markets seem somewhat attractively priced. For bonds, the move in rates certainly pushed them closer to our long-term expectations, but this move may be just the beginning of a series of rate increases.
Overall, Daintree recognizes these solid underlying economic trends, but today’s valuations constrain our enthusiasm. We continue to believe our well-diversified portfolios offer the best approach: clients can participate in the upside while still maintaining sufficient protection in the event economic conditions and markets take a wrong turn.
Our approach produced attractive returns in the tumultuous year that was 2016. The year’s volatility aided after-tax returns by providing opportunities to loss-harvest and offset gains in some taxable accounts. These actions augmented the strong absolute and relative investment returns for clients.
Highlights for the fourth quarter and for 2016:
Over the quarter, the MSCI All Country World index returned a modest 1%, ending the year up 8%. Generally, U.S. stocks outperformed non-U.S. stocks in the quarter, with the S&P 500 up almost 4% and the Russell 2000 (small cap) up 9% on the back of heightened U.S. growth expectations.
Non-U.S. large cap finished the year up only 1% while small cap non-U.S. stocks were up 4%, as exchange rate moves detracted from returns in U.S. dollars. Our primary active managers in both categories beat these results.
Despite a difficult quarter that saw strong asset outflows and negative returns due to unfavorable currency moves, the Emerging Market index finished the year up around 11% in dollar terms, and our active managers performed even better than that.
Overall, Daintree’s allocation to liquid alternatives produced mid-single-digit absolute returns in Q4 and modest positive returns for 2016.
On an individual basis, most of our liquid alternatives managers put up solid absolute returns in Q4, while full-year results were more dispersed.
Most clients experienced strong absolute and relative returns for the year in this asset class.
MLPs produced the best subsector performance of the year, with Daintree’s managers posting 30-plus percent returns (depending on investment vehicle). This result demonstrates the benefits of taking action after identifying a very attractive valuation.
Commodities were another star, with the index up 12% after many weak-performing years. This result demonstrates the benefit of a main tenet of our strategy: don’t abandon diversification when elements of the portfolio perform poorly.
Q4 saw U.S. REITs and non-U.S. REITs struggle, finishing down 3% and 8% respectively, as rising interest rates caused yield-chasing investors to flee. Even so, for all of 2016, REITs were still up 9% (U.S.) and 2% (non-U.S.).
Daintree’s positioning in fixed income produced strong results for the year both in absolute and relative terms. Our overweight in non-core fixed income benefitted performance as non-core outperformed core bonds.
For the year, clients typically outperformed the 2% return of the broad bond benchmark through allocations to non-core bonds such as high yield (+15%) and floating rate loans (+11%).
Clients typically outperformed during Q4 by achieving a positive return while the fixed income benchmark declined by two percent.
We appreciated your confidence and trust throughout 2016’s unexpected twists and turns, and strive to maintain that trust in the coming years.
Print Version – 2016 Q4 Investment Report Commentary
All information in this document is from sources believed to be reliable and is for informational and educational purposes only. It is not intended to be, and should not be construed as, advice, legal or otherwise. Daintree Advisors LLC (“Daintree”) may not have verified the information for accuracy or completeness, and Daintree assumes no liability for damages resulting from or arising out of the use of such information. You are solely responsible for evaluating the merits and risks of the use of this information. To ensure compliance with IRS requirements, we inform you that any federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this document.