QUARTERLY REVIEW AND OUTLOOK OCTOBER 2015

Transcription

1 QUARTERLY REVIEW AND OUTLOOK OCTOBER 2015 Highlights The 3rd quarter experienced higher volatility as global financial markets were uncertain as to the risk of China s economic engine slowing beyond expectations and as to whether the Federal Open Market Committee would vote to raise the US federal funds rate for the first time since 2006 August 24th marked the largest interim decline during a trading day with the Dow Jones Industrial Average dropping more than 1,000 points at the opening bell and the S&P 500 entering a correction for the first time since 2011 All major US Indices ended the quarter in correction territory (greater than 10% off highs) The US economy, after a sluggish first quarter, appears to be back on track (albeit a slow one) with GDP growing at an annual rate of +3.9% for the 2nd quarter, fueled by strong consumer spending and business investment In the US equity market, small cap companies underperformed large cap companies due to heightened concern over global growth The energy sector, including MLPs, experienced another setback as oil inventories increased with minimal corresponding cuts in production The bond markets, both taxable and non-taxable, gained during the quarter as interest rates on US Treasury bonds moved lower AM Global s marketable alternative (diversified hedge funds) exposures performed well during the quarter given the magnitude of the decline in global equity markets however these exposures remain slightly down, collectively, through September While we continue to hold cash levels high in client portfolios, we did invest small amounts in areas that fell significantly and offered attractive prices for long-term investors 2015 AM Global Family Investment Office, LLC. All rights reserved. Page 1

2 What Happened in the Quarter? Market Commentary Sometimes you are reminded to be careful of what you wish for (see excerpt below from our 2nd Quarter letter): If equity markets fall, we would expect portfolios to decline some as well but not nearly to the same degree as equity markets. It is during such a period of market turmoil that we should excel as our portfolios will be better positioned to confidently invest when many others panic or capitulate. It is only after a subsequent recovery that the prudence of this investment strategy will be evident. As shown in the chart below, the 3rd quarter delivered on the correction that we had been anticipating and for which we had prepared. The quarter ended with equity markets, energy, and commodities solidly in correction territory (greater than 10% decline from peak) and in some markets a full fledge bear market (greater than a 20% decline from peak). Asset Class Performance % Total Return 10% 0% -10% -20% -30% 2.9% 3.2% 1.3% 1.2% 1.1% 1.7% 1.8% -0.6% -5.3% -5.1% -6.4% -6.0% -5.3% -7.7% -8.4% -8.7% -11.9% -10.2% -15.5% -17.9% -19.3% -3.0% -4.3% -4.7% -22.1% -30.7% -40% S&P 500 Russell 2000 MSCI World MSCI EAFE MSCI EM Barclays US Aggregate Bond Barclays US Municipal Bond HFRX Global Hedge Fund -39.2% Alerian MLP Q YTD Trailing Twelve Months Performance by Investment Index The headlines that triggered the sell-off centered on China s economic slowdown and the risk of a debt crisis that could impact the global economy. These concerns, coupled with the uncertainty of US interest rate policy, was all investors needed to re-assess equity market valuations. It was no surprise to see these concerns impact 2015 AM Global Family Investment Office, LLC. All rights reserved. Page 2

3 energy, commodities, and emerging markets the most. Also important, but secondary to concerns about a global slowdown, was the risk of profit margins peaking for US companies, which contributed to selling pressures. While we take note of peaking profits, we have experienced markets go through this in prior cycles and believe the associated risks can be managed over time. We prepared for this environment with the understanding that going to cash is not in our playbook. We work to balance investing for the long-term, with risk and opportunity, understanding that we will neither get everything right nor have all assets and markets act in the way we expect. Leading up to this event we had built the highest levels of cash in our portfolios, including the Core Fund, since the inception of our firm. We were (and remain) underweight areas that tend to have more volatility (small cap equity and emerging markets), instead favoring marketable alternatives with the expectation that this exposure would hold up better during market turmoil. While we do not like to see portfolios decline, in this case we are comfortable with the reasons why and are excited for the eventual recovery in the portfolios. The result of these decisions still left us in negative territory for the year, but to a lesser extent than the equity markets as the cash and marketable alternatives held up better than global equity markets. In particular, our allocation to global trading and hedge funds, which we expect to lower overall portfolio volatility, delivered solid results and helped offset the decline from the more directional equity managers that fell as global equity markets corrected. What Worked and What Didn t AM Global Asset Allocation Review and Guidance It s tough to make predictions, especially about the future. Yogi Berra We do not make predictions, only judgments about risk. These judgments led us to enter the third quarter overweight cash and alternatives, neutral on US equities and underweight everything else. These views turned out to be fortuitous as cash and alternatives helped to buffer losses in equities, and US equities held up better than International and Emerging Market equities. This positioning also allowed us to opportunistically make new investments (or size up existing investments) that briefly offered very attractive prices. Unfortunately, this bout of market volatility did not extend long enough or cut deep enough to allow us to invest a majority of our excess cash AM Global Family Investment Office, LLC. All rights reserved. Page 3

4 Strategy and Manager Performance Review Equity Strategies Equity exposure in client portfolios was extremely volatile during the 3rd quarter. In larger cap US equities, our primary manager finished the quarter down -9.5%, underperforming the S&P 500. We also used the down quarter to add a US equity manager into client portfolios, where appropriate. Our investment due diligence finds that this long-only equity manager complements our existing US value equity manager nicely. Both of these US equity managers hold concentrated portfolios of mid- and large-cap companies. In small-cap equities, our passive approach to value and capitalization factors performed poorly on an absolute return measure down -11.7%, but in line with the Russell 2000 index (-11.9%) as should be expected. We remained underweight non-us developed world equities, citing our concerns around global growth in Europe and Asia in previous letters. While this decision looked suspect earlier in the year, international equity indices returned all of their outperformance during the third quarter, retreating -10.2%. The volatility in international equities provided us with an opportunity to add an international value equity manager that has been hard closed to new investors for over a year. We feel fortunate to have remained patient in adding international equity exposure. While we remain underweight, we are excited about our investment with a great international team. Emerging market equity exposure remains a difficult place to be invested right now. Concerns around economic growth in China, the knock-on effects China has on demand for commodities, and, more broadly, falling global growth estimates led to negative pressure on emerging markets. We take some solace in our current position of substantially underweight emerging markets and that the small exposures held up relatively well with our frontier markets manager falling -7.0% in the quarter and our small cap emerging markets manager falling -15.5% in the quarter compared to their respective index, which was down -17.9% (MSCI Emerging Markets). At the moment, we remain underweight emerging markets but are ready to increase exposure when emerging market fundamentals improve. Heading into 2015 some of our best performing investments in client portfolios were midstream energy companies. These companies own and manage pipelines that transport crude oil and natural gas across the country. The decision by congress to increase LNG exports and the expansion of infrastructure to move crude oil domestically has helped this industry and certain high quality names. These companies have benefitted from very strong returns on invested capital and growth in profit distributions for investors. However, a massive correction in energy prices since late 2014, specifically WTI crude oil and natural gas prices, has caused significant corrections to the prices of these businesses. In the midstream energy space, some of these companies experienced rising tides for arguably too long. Although we found this correction at first to be healthy, the size of the correction experienced by some high quality pipelines with dominant market presence became oversold and offered very compelling long-term investment opportunities. While adding to these volatile positions throughout the quarter resulted in both temporary losses and gains, we are confident in the long-term fundamentals of these businesses, 2015 AM Global Family Investment Office, LLC. All rights reserved. Page 4

5 their ability to grow distributions to shareholders, and their ability to maintain market share in the midstream energy transportation sector. Fixed Income Remaining substantially underweight fixed income strategies did not help in what was a strong quarter for bonds, cash, and other alternative strategies. The Barclays Aggregate Bond Index finished the quarter +1.2%. A majority of our fixed income exposure for clients is allocated to a municipal high yield strategy. The High Yield Muni manager advanced +2.0% during the quarter versus the Barclay Municipals index s return of +1.7%. In the AM Global Core Fund, we began winding down credit investments that have been in the portfolio for a few years now. Heading into the 3rd quarter, we were able to decrease these position sizes and that decision worked out well as distressed credit strategies performed poorly during the quarter. Marketable Alternatives We allocate to various risk drivers and over time expect to be compensated for assuming these risks. Our expected result is a stronger risk adjusted return versus just holding the market in a passive investment approach. In marketable alternatives, various risk drivers include manager risk, equity risk, and credit risk to name a few. During the third quarter, there was extreme dispersion in returns depending on the strategy being implemented. Some long bias equity strategies with concentrated portfolios suffered significantly, such as event driven and activist strategies. However, more quantitative and systematic trading strategies generated profits. Ultimately, marketable alternatives, and more specifically the AM Global Core Fund, outperformed global equity markets during the quarter and thus far year to date, helping protect capital in portfolios that are tilted to take equity risk. The AM Global Core Fund finished the quarter down -4.5% and is now down -2.0% for the year. This compares to the MSCI World index s return of -8.4% during the quarter and -6.0% for the year and the hedge fund index (HFRX Global Hedge Fund Index) return of -4.3% in the quarter and -3.0% for the year. Additionally, earlier this year we began investing in a multi strategy mutual fund managed by Blackstone which allocates to various hedge fund managers whom we are very familiar with. In fact, we have direct investments with a few of the managers in Blackstone s fund. We are very happy with this mutual fund s performance thus far gaining +0.2% in the quarter and +3.5% year to date. In our marketable alternatives allocations, market neutral and global trading strategies have been working very well. Our core market neutral manager, currently a 10% allocation in the AM Global Core Fund, is up +15.6% year to date following a +16.2% quarter. Abbey Capital, our core global trading investment, also delivered a positive result in the quarter with a +3.5% return. Large long positions in global bonds and short positions in energy, commodities, and equities helped the global trading strategy generate profits by taking advantage of trends, both long and short, in asset prices. On the other hand, long bias event driven and long bias long/short strategies performed poorly in the quarter. Activism, a form of event driven investing used by hedge fund managers in order to try and maximize shareholder 2015 AM Global Family Investment Office, LLC. All rights reserved. Page 5

6 wealth by engaging management and encouraging change, was significantly impacted during the quarter. We used this opportunity to re-underwrite three of our managers and to initiate more frequent communication to determine if we should take advantage of the decline and add to our investment or determine that a problem exists that would require a termination. While we are never happy when any of our managers have a significant decline, such times can provide an opportunity to buy a cheaper portfolio and with the proper due diligence make a confident decision to increase our investment with the expectation that the reward will come as the portfolio recovers. By the end of the quarter, we added to two of the managers and kept the other manager at the same weighting. What Should You Expect Going Forward? Investment Outlook As we look forward to the 4th quarter and 2016 we feel more comfortable about the risk and return balance than we did at this time last year. While we are not jumping in with both feet, we do believe that a global economic crisis or severe bear market is not in our near future. As a result, we expect the balance of the year to reward us for adding to the areas hit hard this year (both managers and individual company positions). Of course there are a number of things that could go wrong and send markets down, but our current portfolio positioning remains underweight equity risk and overweight cash and marketable alternatives, and as a result we continue to believe we are in a good position to participate in a rising market but remain on solid footing through another rough market. Why are we more positive today? First, the decline in equity and commodity markets renewed investors sensitivities towards risk and as a result helped lower many of the overly optimistic views of what a reasonable return should be on investments in these markets. Also, despite slowing revenue growth and possibly lower profit margins, US companies are in good financial condition. If the economy can continue to grow moderately with stable inflation and interest rates remain low, the consumer should be able to support the growth trajectory and in turn equity market valuations. With this said, we do believe the global markets do have risks covering economic and geo-political circumstances that will likely keep volatility on the higher end over the next year. This condition should provide a good environment for hedge fund managers as well as fundamental equity managers that discern value among companies across global markets AM Global Family Investment Office, LLC. All rights reserved. Page 6

7 As shown below we have not changed our recommended allocation weightings but we did add a couple percentage points to international equity in early October and in some cases increased emerging markets for those portfolios with more appetite for risk. AM Global Asset Allocation Guidance October We will be patient with the cash position given our view that it is critical to have liquidity to take advantage of opportunities that may arise in this uncertain investing climate. Portfolio Changes We have no immediate changes to our portfolio allocation guidance from last quarter. However, we did take advantage of the volatility, investing a good portion of our cash earmarked for marketable alternatives by adding to hedge fund managers on October 1st that had a rough quarter. The managers that we believe have a sustainable process and edge will have periods (sometimes longer than we would like) of underperformance, but if there is one thing we have learned over the last 25 years, these are often times to add, not cut. As we indicated in our last letter, we believe the ultimate recovery will deliver strong results by taking action when most are exiting good investments at lower values because of short-term events. We were excited to have the opportunity to take advantage of the market volatility. The investment process we use and trust has been developed, tested, and enhanced over the past two decades incorporating proven investment techniques and processes. We believe that we can achieve success for our clients by focusing on portfolio construction, managing risk, and thoughtfully embracing diversification. This philosophy, together with maintaining a conflict-free professional investor culture, is how we will help you accomplish your investment objectives over the long term AM Global Family Investment Office, LLC. All rights reserved. Page 7

8 What s New With AM Global? We are pleased to announce that we hired an exceptional new Investment Analyst, Sean Boner, in August. Sean comes to us with a background in forensic accounting and has already completed Levels 1 & 2 of the CFA (Chartered Financial Analyst) program. Sean is already providing us with much greater bandwidth in tracking and modeling a diverse array of financial and economic information; he has hit the ground running to say the least. We also were able to renew the lease of our office space here in West Palm Beach for another three years and are in the process of building out an additional conference room, primarily for manager calls and meetings. Lastly, we (and many of you) have been working with McGladrey over the summer months to complete our annual custody audit, which we expect to be wrapped up soon. We greatly appreciate your help and patience in this important process. Thank you for placing your trust in us. Please let us know if we can be of further assistance to you or if you have any questions we can help to answer. Best regards, Andrew Mehalko, CFA Founder & CIO 319 Clematis Street, Suite 300 West Palm Beach, FL PH andrew@amglobalfio.com AM Global Family Investment Office, LLC. All rights reserved. Page 8

9 IMPORTANT DISCLOSURES NEITHER THE INFORMATION PROVIDED NOR ANY OPINION EXPRESSED HEREIN CONSTITUTES AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OR SERVICES TO ANY PERSON. ANY SUCH OFFER OR SOLICITATION WILL BE MADE TO QUALIFIED INVESTORS ONLY BY MEANS OF A FINAL OFFERING MEMORANDUM AND ONLY IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW. THIS MATERIAL IS GENERAL INFORMATION ONLY AND IS NOT INTENDED TO BE USED AS THE BASIS FOR INVESTMENT DECISIONS AND IS NOT INTENDED TO ADDRESS THE PARTICULAR CIRCUMSTANCES OR NEEDS OF ANY SPECIFIC PERSON WHO MAY READ IT. PRIOR TO MAKING ANY INVESTMENT DECISION, YOU SHOULD INDEPENDENTLY EVALUATE THE RELEVANT RISKS INVOLVED AND ENSURE THAT SUCH INVESTMENT IS APPROPRIATE AND SUITABLE FOR YOU IN LIGHT OF YOUR INVESTMENT OBJECTIVES, TRADING EXPERIENCE, TIME HORIZON, FINANCIAL RESOURCES, AND OTHER RELEVANT CIRCUMSTANCES. INVESTMENT RISKS INCLUDE, WITHOUT LIMITATION, POLITICAL RISK, SOVEREIGN RISK, ECONOMIC RISK, CURRENCY RISK, CREDIT RISK, AND LIQUIDITY RISK. PAST PERFORMANCE SHOULD NOT BE CONSTRUED AS AN INDICATOR OF FUTURE PERFORMANCE. THE INFORMATION CONTAINED IN THIS QUARTERLY REVIEW AND OUTLOOK HAS BEEN COMPILED FROM SOURCES BELIEVED TO BE RELIABLE, BUT NO REPRESENTATIONS OR WARRANTY, EXPRESS OR IMPLIED, IS MADE BY AM GLOBAL WEALTH MANAGEMENT (THE COMPANY ) OR ANY OTHER PERSON AS TO ITS ACCURACY, COMPLETENESS OR CORRECTNESS. ALL OPINIONS AND ESTIMATES CONTAINED HEREIN CONSTITUTE THE COMPANY S JUDGMENT AS OF THE DATE OF THIS QUARTERLY REVIEW AND OUTLOOK AND ARE SUBJECT TO CHANGE WITHOUT NOTICE. CERTAIN INFORMATION CONTAINED HEREIN IS ESTIMATED AND UNAUDITED AND MAY BE SUBJECT TO ADJUSTMENT. Benchmarks and Indices: The valuation information shown for the various indices is available from public sources. The Company makes no representation as to its accuracy. An investor may not invest directly into an index. Comparisons between a composite and an index or benchmark are unreliable as performance indicators and should not be considered indicative of the actual performance to be achieved in a particular account. Barclays Aggregate Bond: Composed of U.S. investment grade fixed rate bond market, including government and credit securities, agency mortgage pass through securities, asset backed securities, and commercial mortgage based securities. Barclays US Municipal Bond: Is a broad-based benchmark that measures the investment grade, US dollardenominated, fixed tax exempt bond market. The index includes state and local general obligation, revenue, insured, 2015 AM Global Family Investment Office, LLC. All rights reserved. Page 9

10 and pre-refunded bonds. The US Municipal Index was incepted in January ML Municipal 3-7 Year Bond: Composed of state and local general obligation bonds, revenue bonds, and insured bonds. This index is focused on the intermediate range or maturities between 3 and 7 years. Barclays High Yield: Covers much of the below investment grade U.S. corporate bond market. To be included in the index, an issue must be rated speculative (BB+/Ba1) by S&P or Moody s. An issue must miss a scheduled interest payment and allow the 30 day grace period to lapse before it is removed from the index. Merrill Lynch 91 Day U.S. Treasury Bill Index: Is comprised of a single issue purchased at the beginning of the month and held for a full month. At the end of the month, that issue is sold and rolled into a newly selected issue. The issue selected at each month-end is then re-balanced and becomes the outstanding Treasury Bill with the longest maturity. To qualify for selection, an issue must have settled on or before the re-balancing (month-end) date. Morgan Stanley Capital International (MSCI) Europe, Australia, and the Far East (EAFE) Equity Index: MSCI EAFE acts as a benchmark for 23 developed markets stock markets, approximately 1000 publicly traded companies. The average company has a market capitalization of over $3 billion. The index is presented with net dividends in U.S. dollars. MSCI World Index: Captures large and mid-cap representation across 23 developed market countries, including the United States. Morgan Stanley Capital International (MSCI) Emerging Markets: In 1988, MSCI launched the first comprehensive emerging markets index. Since then, emerging markets have become an important and integrated part of a global equity portfolio allocation. In 1988, there were just 10 countries in the MSCI Emerging Markets Index, representing less than 1% of world market cap. Today the MSCI Emerging Markets Index covers over 800 securities across 21 markets and represents approximately 13% of world market cap. S&P 500: The S&P 500 consists of 500 widely held common stocks, consisting of four broad sectors (industrials, utilities, financial and transportation). It is a market-value weighted index (stock price times shares outstanding), with each stock affecting the index in proportion to its market value. This index is a total return index with dividends reinvested. Russell 2000 : The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set. HFRI Hedge Fund Index: HFR utilizes an objective, rules-based methodology that includes over 2000 hedge funds across four main strategies, each with multiple sub-strategies. The index seeks to combine and weight these strategies to provide a representation of the composition of the global hedge fund universe. The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies; including but not limited to convertible arbitrage, distressed securities, equity hedge, equity market neutral, event driven, macro, merger arbitrage, and relative value arbitrage. SPDR Gold Shares: SPDR Gold Shares are intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that interest through the trading of a security on a regulated stock exchange AM Global Family Investment Office, LLC. All rights reserved. Page 10

11 DEFINITIONS Standard Deviation: Standard Deviation measures the dispersal or uncertainty in a random variable (in this case, investment returns). It measures the degree of variation of returns around the mean (average) return. The higher the volatility of the investment returns, the higher the standard deviation will be. For this reason, standard deviation is often used as a measure of investment risk. Drawdown: any losing period during an investment record. It is defined as the percent retrenchment from an equity peak to an equity valley. A Drawdown is in effect from the time an equity retrenchment begins until a new equity high is reached. (I.e. In terms of time, a drawdown encompasses both the period from equity peak to equity valley (Length) and the time from the equity valley to a new equity high (Recovery). Maximum Drawdown: The largest percentage Drawdown that has occurred in any investment data record. Correlation: Correlation measures the extent of linear association of two variables. For example, how related the returns are between investments. Quarterly Returns: Cumulative return for the specified quarter. Trailing Twelve Month Return: Cumulative return for the latest twelve months. Master Limited Partnership (MLP): A limited partnership that is publicly traded. MLP s produce income streams from activities related to the partnership and attributed to infrastructure, natural gas, energy, exploration and pipeline activities. Real Estate Investment Trust (REIT): An exchanged traded security that invests in real estate activities and distributes cash to shareholders in a tax advantageous manner. There are three main types of REITs: Equity REITs, Hybrid REITs, and Mortgage REITS. International Equity: Investments in public international companies that are non-u.s. firms. International Equities tend to be domiciled in Developed ex-u.s. countries. Emerging Market: Investments in publicly traded emerging market countries, emerging market economies are economies that are progressing toward becoming advanced. Common examples of emerging market economies include Brazil, South Korea, and, but not limited to, India. Long/Short Equity: Long exposure in equities and short exposure in equities. The net exposure of long positions minus short positions tends to have a positive bias to equity markets. Multi-Strategy: Deploys its underlying investments with a variety of strategies and portfolio managers that are part of the same organization with a single layer of fees. Global Trading: Strategies that include discretionary trading - using the judgment of human influences and systematic trading - using software and computer programs. Event Driven: Diversified strategies that participate in opportunities in both corporate debt and equity securities, merger activity, and but not limited to debt defaults. Special Situations: Broad sub strategy of special situations specific to a current theme. Special situations invest across different events and typically focus on equities. Market Neutral: Typically establish both long and short positions that neutralize equity market risk and beta. Alpha can be targeted through security selection AM Global Family Investment Office, LLC. All rights reserved. Page 11