William A. Hummel Managing Principal Investment Briefing November 12, 2015
AGENDA I. MARKET UPDATE II. CURRENT ENVIRONMENT III. INVESTMENT OPPORTUNITIES IV. QUESTIONS 2
MARKET UPDATE
CHINA S DEBT OVERHANG LOOMS OVER THE MARKET DRAMATIC CHINA DEBT INCREASE Debt-to-GDP Ratio (percentage) 300% 250% 200% 150% 100% 50% 0% Total Debt $ (trillion) 121% 158% 282% 2000 2007 2Q 2014 2.1 7.4 28.2 China s debt reached 282% of GDP as of Second Quarter 2014, surpassing the United States (269%) and Germany (258%) Note: Numbers may not sum due to rounding. Source: MGI Country Debt database; McKinsey Global Institute analysis 4
SHOCKWAVES FROM CHINA S YUAN DEVALUATION YUAN vs. U.S. DOLLAR ON AUGUST 11, 2015 0.162 0.161 0.160 0.159 2AM 4AM 6AM 8AM 10AM 12PM 2PM 4PM 6PM 8PM 10PM 12AM 2AM Source: CNNMoney 5
Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term." - Janet Yellen, September 2015 6
FED RATE: A RATE HIKE IS STILL ON THE HORIZON MONTHS TO FIRST FED RATE HIKE MS M1KE Index DXY Index 35 105 30 100 Number of Months 25 20 15 10 95 90 85 80 U.S. Dollar (DXY) Index 5 75 0 2009 2010 2011 2012 2013 2014 2015 70 Data sources: Morgan Stanley, Bloomberg, L.P.; Data as of 9/30/2015 7
FED RATE: FOMC PROJECTS HAWKISH TONE AFTER OCTOBER MEETING Probability of December 16-17 FOMC Rate Hike 55% 50% 50% Probability 45% 40% 35% 30% 25% Apr-15 Jun-15 Aug-15 Oct-15 Data source: Bloomberg, L.P.; Data as of 10/29/2015 @ 10:00am ET Sentiment surrounding the FOMC s October 27-28 meeting took-on a hawkish tone, partially driven by the removal of the statement recent global economic and financial developments may restrain economic activity somewhat. 8
CURRENT ENVIRONMENT
The market s not a very accommodating machine; it won t provide high returns just because you need them. - Peter L. Bernstein, Financial Historian (1919 2009) 2014 FEG Investment Forum 10
FEG CAPITAL MARKET ASSUMPTIONS FEG 10-Year Capital Market Assumptions Expected Return Expected Standard Deviation Expected Return Expected Standard Deviation Global Equity Real Assets Long-Only Strategies 6.3% 23.6% Real Estate U.S. Equity 5.2% 21.6% Public Real Estate 5.0% 17.0% Large Cap 5.0% 20.0% Private Real Estate 8.5% 25.0% Mid Cap 5.5% 24.0% Natural Resources Small Cap 6.0% 26.0% Commodities 4.5% 25.0% Timber 6.0% 11.0% International Equity 7.3% 25.6% Private Energy 10.0% 30.0% Large Cap Developed 6.5% 22.0% Infrastructure Small Cap Developed 7.0% 26.0% MLPs 8.5% 26.0% Emerging Markets 9.0% 33.0% Frontier Markets 10.0% 35.0% Diversifying Strategies Semi-liquid Hedged Strategies 5.2% 9.2% Global Hedged Equity 5.0% 15.0% Event Driven 5.5% 9.0% Private Equity 10.0% 35.0% Macro 5.5% 12.0% Relative Value 4.5% 8.0% Global Fixed Income/Credit Interest Rate Sensitive Strategies 2.4% 6.3% Liquid Diversifying Strategies 4.0% 9.0% Core (Investment Grade) 2.2% 6.0% Inflation Protected (TIPS) 2.5% 6.0% Long Duration Corporate Debt 4.0% 8.5% Money Markets Emerging Market Debt 5.5% 14.0% U.S. Inflation 2.0% U.S. Cash 1.5% Credit Sensitive Strategies 6.0% 16.0% High Yield 5.5% 15.0% Bank Loans 4.5% 12.0% Private Debt 8.0% 21.0% 11
LOW YIELDS, TEPID LONG-TERM RETURNS U.S. TREASURY YIELDS Yield 2-Year 10-Year 30-Year 18% 16% 14% 12% 10% 8% 6% 4% 2.85% 2% 2.04% 0% 0.63% 1979 1985 1991 1997 2003 2009 2015 Source: Bloomberg, L.P.; Data as of 09/30/2015 12
MODIFYING EXPECTATIONS TO ENVIRONMENT EXPECTED RETURN VS. EXPECTED RISK Historical Current Expectations Return Primary Objective Risk 13
INVESTMENT OPPORTUNITIES
EQUITY: WHAT S GOING ON IN THE EMERGING MARKETS HISTORICAL VALUATIONS: EMERGING MARKETS vs. U.S. PRICE / 5-YEAR NORMALIZED EARNINGS MSCI Emerging Markets vs. S&P 500, 2000 Present MSCI Emerging P/E5 40x U.S. P/E5 Nominal Price / Earnings (Nominal 5-Year Normalized) 35x 30x 25x 20x 15x 10x 21.8x 12.0x 5x 0x 2000 2002 2004 2006 2007 2009 2011 2013 2015 Data sources: MSCI & Robert Shiller; Data as of 09/30/2015 15
EQUITY: PROFIT MARGINS 16
EQUITY EMERGING MARKETS CURRENCY INDEX 17
EQUITY: HEDGED EQUITY, A GOOD OPPORTUNITY? ROLLING 5-YEAR RELATIVE PERFORMANCE HFRI Equity Hedge Minus S&P 500 Index 20% Relative Performance Percentage Points 15% 10% 5% 0% -5% -10% Tech Bubble Hedged Equity Outperforms Housing Bubble S&P 500 Outperforms Stimulus Bubble -15% 1994 1996 1998 2000 2002 2004 2005 2007 2009 2011 2013 2015 Source: HFRI Standard & Poors; Data as of 07/31/2015. 18
FIXED INCOME: RETURN POTENTIAL DOES NOT JUSTIFY THE RISK U.S. HIGH YIELD BOND SPREADS OVER TREASURY YIELDS High Yield Spread (percentage points) 20 18 16 14 12 10 8 6 4 2 Altman Annual Default Rate Barclays U.S. High Yield Index Average Spread 20% 18% 16% 14% 12% 10% 8% 5.4 4.8 6% 4% 2% Default Rate 0 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 0% Data sources: Altman, Barclays Capital; data as of 05/31/2015 19
IS THERE AN ATTRACTIVE MASTER LIMITED PARTNERSHIPS (MLP) YIELD? MLPs DISTRIBUTION YIELD vs. 10-YEAR TREASURY YIELD 12 MLP Distribution Yield vs. 10-Year Treasury Yield Average 10 Yield Spread (percentage points) 8 6 4 2 6.0 3.2 0 1996 1998 2000 2001 2003 2005 2007 2009 2011 2013 2015 Data sources: Alerian Capital Management, Bloomberg L.P.; Data as of 09/30/2015 20
IMPORTANCE OF DIVERSIFICATION IN VOLATILE MARKETS PERFORMANCE OF MAJOR GLOBAL EQUITY MARKETS August 2015 0% -2% -4% -6% -8% -10% -12% -14% Diversifying Strategies* S&P 500 Index MSCI AC World Index Euro Stoxx 50 Index Shanghai Composite Index Nikkei 225 Index Data Source: PerTrac Analytics *1/3 in the HFRI Relative Value Index, HFRI Event Driven Index, and HFRI Macro Index 21
DIVERSIFYING STRATEGIES: MONEY FOR NOTHING AND DEALS FOR FREE MERGERS AND ACQUISITIONS (M&A) ACTIVITY North America $750 Volume Deal Count 4500 Deal Volume (million) $500 $250 $0 3500 2500 1500 500-500 Deal Count Western Europe Deal Volume (million) Volume $500 $400 $300 $200 $100 Deal Count 2500 2000 1500 1000 500 Deal Count $0 0 Source: Bloomberg L.P.; Data as of 9/30/2015 22
SUMMARY
MARKET SUMMARY The late-august Swoon: China s currency devaluation was the catalyst but not the cause. US stocks were, and are, over-valued. Interest rates may not start rocketing higher, but the duration tailwind is over. Expectations for future returns should be tempered in a lower-return, post quantitative easing (QE) world. 24
FHCCF ASSET ALLOCATION BY ASSET CLASS FHCCF Current % 1% 3% 3% 15% 13% 9% 6% 5% 11% 9% 5% 14% 6% FHCCF Target % 0% 6% 3% 13% 12% 9% 5% 5% 11% 10% 14% 5% 8% Large Cap Equity Mid Cap Equity Small Cap Equity International Equity Emerging Markets International Small Cap Core Fixed Income Bank Loans High Yield Diversified Hedge Public Natural Resources Private Equity - Distressed Money Market Asset Allocation by Asset Class FHCCF Current % FHCCF Target % Large Cap Equity 14.6% 13.0% Mid Cap Equity 9.3% 9.0% Small Cap Equity 11.0% 10.5% International Equity 13.7% 14.0% Emerging Markets 6.3% 8.0% International Small Cap 5.2% 5.0% Core Fixed Income 9.3% 10.0% Bank Loans 5.0% 5.0% High Yield 6.2% 5.0% Diversified Hedge 12.8% 12.0% Public Natural Resources 3.4% 6.0% Private Equity - Distressed 2.7% 2.5% Money Market 0.5% 0.0% 100.0% 100.0% Data source: FEG Data. As of 9/30/2015. 25
FHCCF ASSET ALLOCATION BY MANAGER Asset Allocation by Manager 1% 2% 1% 4% 6% 13% 5% 1% 2% 6% 5% 5% 5% 7% 4% 3% 7% 5% Data source: FEG Data. As of 9/30/2015. 9% 4% 4% 4% 26 Q-Blk Alpha Transport Vanguard Index 500 Fund ClearArc Div. Growth Above Market Yield T. Rowe Price Inst. Large Cap Growth DFA U.S. Large Cap Value Fund Vanguard Mid Cap Index Fund Vanguard Small Cap Index Fund Schwab Fundamental Small Co. Index DFA US Small Cap Value Fund Europacific Growth Fund Dodge & Cox International Fund Templeton Instl. Foreign Smaller Co. Fund DFA Emerging Markets Small Cap Fund DFA Emerging Markets Value Fund Ridgeworth SEIX Floating Rate Fund Loomis Sayles Bond Fund Franklin Templeton Global Bond Fund Fidelity Real Estate High Income Fund PIMCO Commodity Real Return Fund JP Morgan Alerian MLP ETN Weatherlow Offshore Fund Strategic Value Special Situations II Strategic Value Special Situations III Cash 21 Managers 3 Large Cap Equity Managers 1 Mid Cap Equity Manager 3 Small Cap Equity Managers 5 International Equity Managers (Includes Emerging Markets) 6 Fixed Income Managers (Includes Private Debt) 1 Diversified Hedge Fund of Funds Managers 2 Public Natural Resources
LONG TERM TARGET RETURNS FHCCF Goal: Achieve Real Growth: Return above Spending, Inflation, and Administrative Expenses 1 Formula: Spending + Inflation + Administrative Fees = Minimum Long-Term Target Return 4.5% + 2.0% + 1.2%* = 7.7% A 7.7% return will ensure intergenerational equity. In other words, spending today will have the same economic impact as future spending in real dollars (adjusted for inflation). 1 Administrative expenses include costs incurred to oversee the portfolio, such as salaries, custodian costs, consulting fees, legal fees, and other administrative costs. Some institutions include this as part of the spending policy. Investment manager fees are not included, as the capital market expectations are assumed to be either a passive representation of the asset category or the median return, net of fees. *Scholarship funds have an effective administrative fee of 2.2%. 27
FEG CAPITAL MARKET ASSUMPTIONS FEG 10-Year Capital Market Assumptions Expected Return Expected Standard Deviation Expected Return Expected Standard Deviation Global Equity Real Assets Long-Only Strategies 6.3% 23.6% Real Estate U.S. Equity 5.2% 21.6% Public Real Estate 5.0% 17.0% Large Cap 5.0% 20.0% Private Real Estate 8.5% 25.0% Mid Cap 5.5% 24.0% Natural Resources Small Cap 6.0% 26.0% Commodities 4.5% 25.0% Timber 6.0% 11.0% International Equity 7.3% 25.6% Private Energy 10.0% 30.0% Large Cap Developed 6.5% 22.0% Infrastructure Small Cap Developed 7.0% 26.0% MLPs 8.5% 26.0% Emerging Markets 9.0% 33.0% Frontier Markets 10.0% 35.0% Diversifying Strategies Semi-liquid Hedged Strategies 5.2% 9.2% Global Hedged Equity 5.0% 15.0% Event Driven 5.5% 9.0% Private Equity 10.0% 35.0% Macro 5.5% 12.0% Relative Value 4.5% 8.0% Global Fixed Income/Credit Interest Rate Sensitive Strategies 2.4% 6.3% Liquid Diversifying Strategies 4.0% 9.0% Core (Investment Grade) 2.2% 6.0% Inflation Protected (TIPS) 2.5% 6.0% Long Duration Corporate Debt 4.0% 8.5% Money Markets Emerging Market Debt 5.5% 14.0% U.S. Inflation 2.0% U.S. Cash 1.5% Credit Sensitive Strategies 6.0% 16.0% High Yield 5.5% 15.0% Bank Loans 4.5% 12.0% Private Debt 8.0% 21.0% 28
MONTE CARLO SIMULATION Monte Carlo is a random sampling computer simulation used to obtain approximate solutions to mathematical or physical problems, especially in terms of a range of values, each of which has a calculated probability of being the solution. The following simulation generated 5,000 iterations of investment returns based on the expected return and standard deviation of the portfolios. We are then able to analyze the expected range of returns for periods longer than one year (e.g., 10 years). This analysis assists in evaluating long-term impacts of asset allocation. Long-term returns are less than the one year arithmetic returns, due to the negative effect of volatility.* * Assumes standard deviation > 0% 29
FHCCF DETAILED ASSET CATEGORY ALLOCATION 1 Year Target Expected Return 7.8% Standard Deviation 16.5% 10 Year - Monte Carlo Simulation 95th Percentile 15.8% 75th Percentile 10.2% Expected Return 6.5% Hurdle Rate 7.7% 25th Percentile 3.0% 5th Percentile -2.0% Asset Mix U.S. Large Cap 13.0% U.S. Mid Cap 9.0% U.S. Small Cap 10.5% International Developed 14.0% International Small Cap 5.0% Emerging Markets 8.0% Frontier Markets 0.0% Private Capital 2.5% Core Bonds 10.0% High Yield 5.0% Bank Loans 5.0% Diversifying Strategies* 12.0% Commodities 4.0% MLPs 2.0% Real Estate 0.0% Cash 0.0% Source: FEG Data *The Foundation s current investment of Evanston Weatherlow is modeled as 50% Long/Short Equity and 50% Absolute Return. 30
QUESTIONS? 31
BIOGRAPHY William A. Hummel Managing Principal Investment Professional since 1990 FEG team member since 1995 William A. Hummel 513.719.5122 bhummel@feg.com www.feg.com Education: BS in Accounting, Xavier University Experience: Fidelity Investments Retirement Plan Specialist Presentations: Physician Management Practice Forum for the Healthcare Financial Management Association (HFMA) Southwestern Ohio Chapter National Business Institute (NBI) Professional Association for Investment Communications Resources (PAICR) National Business Officers Association (NBOA) Community Foundations of Butler County Memberships: Great Miami Valley YMCA Board of Directors Past Memberships: St. Xavier High School Investment Committee 32
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