Investment Newsletter 3Q18
Your Investments and Ambassador Wealth:
Enhancements to Your Investments After My First Year
Stuart P. Quint, III, CFA
Managing Director, Investments and Compliance
- Update on returns for different asset classes.
- 5 improvements to how we manage your investments
- Continue with cautious optimism and selective stance on risk assets
I wanted to change the format specifically for this letter to share with you some enhancements to our process. April marked one year since I started working with Petr at Ambassador Wealth Management.
Along with a brief market update, I wanted to share with you some additional benefits to your investments we have implemented during this time.
Related to the quarter, US stocks and high yield corporate bonds rebounded after lackluster performance earlier in the year. Corporate earnings were solid, and the US economy displayed strength. In contrast, government bonds and international equities declined.
Bonds fell as the Fed showed further desire to raise interest rates.
International equities suffered from political turmoil in Europe, uncertainty over US-China trade, and reductions in economic expansion.
Commodities were volatile as the rally in oil petered out. Strong demand provided a backdrop for concerns on supply. At first, prices rose in response to worries about supply from Venezuela and Iran being curtailed. The subsequent response by Saudi Arabia and Russia to stabilize the market caused oil to stumble. The real question, though, is how much spare supply really exists to balance markets.
Our positions on different asset classes have not changed, nor has our list of concerns. You can read about them here. We plan a portfolio reallocation in the third quarter and will communicate changes as needed.
The table below updates you on returns for the quarter and year thus far in various asset classes:
|Asset Category||Total Return in 1Q18||Total Return in 2Q18||Total Return in 2018 YTD|
|Russell 2000 (US Small Cap Stocks)||-0.2%||+7.9%||+7.7%|
|MSCI EAFE (International Developed Equities)||-0.9%||-1.9%||-2.8%|
|MSCI EM Free (International Emerging Markets)||+2.6%||-9.4%||-7.0%|
|GSCI Commodity Index (Commodities)||+1.8%||+4.1%||+6.0%|
|Barclay Aggregate (Fixed Income)||-1.5%||-0.1%||-1.6%|
|Barclays High Yield (High Yield Corporate)||-1.5%||+0.6%||-0.9%|
5 Investment Enhancements after One Year at AWM
Warning: this letter will be somewhat geared for “investment nerds.”
While a little technical, you still might care to read further. We want to share with you insights on how we are striving to manage your portfolios better.
When I joined Petr last April, my role was to review the investment mix of different portfolios and recommend changes. The goal was to help investors weather through the coming transition in markets.
Specifically, Petr tasked me to find ways to reduce risk and expense as we enter the late stage of the bull market with the likelihood of higher volatility compared to the recent past.
5 major changes that impacted your portfolios include:
Align investments to reflect environment, generate return, and reduce downside risk
We are late in a bull market. It might continue for several more years to come. It is also possible we might see a more significant correction if the economy were to contract.
Regardless, we have already seen a larger drawdown (market decline) this year than during all of last year’s run. 1q18 gave us a reminder that markets do not simply go straight up.
Because of the full valuation in many asset classes, simply assuming the bull market returns of the last decade persist might appear naïve. Assuming investment returns of the last decade repeat in the next decade might not be a safe assumption. Hence, we should have some skepticism about the future.
As stated in prior newsletters, we are cautiously optimistic, not bearish at all. However, we are also mindful that bouts of volatility can break out. One major factor at play is the extent to which the Fed raises interest rates. After an historically unprecedented cutting of interest rates, the Fed wants to play “catch-up”. Unlike other cycles, the Fed has much more influence on long-term as well as short-term interest rates. The transition from a depressed to a “normal” interest rate environment might entail risks to markets. Higher volatility in risk assets might be a reasonable consequence of such a transition.
However, fixed income might not provide the benefits of diversification that it once did. It is conceivable to have an environment where core fixed income might decline even if “risk-on” assets such as equities were also to decline. Such was the case in the first quarter of 2018, when both stocks and bonds fell in value.
We have sought to diversify your portfolios in order to participate in further growth in the economy (especially the US).
Furthermore, we want to take prudent risks and not chase overvalued assets with peaking fundamentals (think “avoid asset bubbles”, such as housing in 2006).
Focus on where we can add value (and where we should not bother)
People at times can take unnecessarily extreme positions on complex subjects.
The active/passive debate is one of those subjects.
Some people (a shrinking minority) would have you put all your investments into actively-managed mutual funds and other active vehicles. As we will see later, in many cases, this is an expensive solution that often does not yield positive offsets for investors.
Other people (a growing popular view) tout exclusive use of passive vehicles such as Exchange Traded Funds. They present data that suggests most managers cannot add significant value beyond the indices represented by the Exchange Traded Funds (ETF’s). “If you can’t beat them, join them?”
We have taken a more nuanced view with your investments. Both passive and active investment vehicles can play helpful roles in your portfolio:
- Passive – in general, passive vehicles such as ETF’s are cheaper than active vehicles such as Mutual Funds. Areas where we believe passive makes more sense include: large domestic equities, major portions of international equities, and core fixed income.
- Active – inefficiencies exist in certain asset classes that active managers can exploit in favor of investors. In fact, many of the current ETF structures actually are more volatile and of greater risk than active funds, particularly in fixed income. Examples include: Japanese equities, small cap equities, high yield credit.
Enhancement to investor returns through lower costs
A benefit of improving your mix of investments is the potential for cost savings. We seek ways to pass these savings on to you and still maintain a robust, diversified portfolio.
How much? The answer depends on how you were invested before we relocated your portfolios.
For large investors whose portfolios consist of stocks, we saved you roughly 20%, or $2, per trade by switching custodian from LPL to TD Ameritrade. This cost savings does not consider additional benefits to you such as improved trading execution and lower risk of error with automated trading.
For most of our clients invested primarily in mutual funds and ETF’s, we estimate that you might have received a reduction in annual fund expenses of nearly 50 basis points (0.50% or one half of a percent each year). (Your specific portfolio might vary from that of other clients, so we cannot assure you this exact number will apply to you.)
An additional one half of percent of return every year going forward is a tangible benefit to you.
How did we do that? Two ways:
- Where we chose to add value through manager selection, we also ended up finding cheaper funds. Not only are you benefiting from some potentially great managers, but you also are helped by paying lower expense ratios in the fund classes we use. Institutional share classes, also known as “I” shares, often carry lower expense ratios than other share classes.
- Where we did not see opportunity to add value with active managers, we swapped out of expensive mutual funds into less expensive Exchange Traded Funds (“ETF’s”). As an example, swapping out of the average US large cap equity fund manager into one of the most popular S&P 500 ETF’s used would save nearly 1.35% (135 basis points) on that portion of an investor’s portfolio. Doing a similar swap from the average bond fund to one of the popular core bond ETF’s could save nearly 0.85% (85 basis points) on that portion of the portfolio. Lower expense ratios and trading costs on stocks and ETF’s add real benefits to your investments.
Trading: Increase efficiency and fairness, mitigate operational risk
Trading is like the computer help desk at a company. No news is good news, but bad news travels fast.
Becoming a world-class RIA means you have to have top notch trading. The ideal system is one that allows the manager to react quickly, treat all accounts involved equally, and reduces the risk of error.
New trading software introduced late last year significantly improves our ability to help your portfolios. One of the reasons we chose to go with TD Ameritrade as our new custodian was their emphasis on cutting-edge technology. iRebal is an integrated software tool that allows us to trade more quickly and ensure more thoroughly that all clients receive fair execution on their trades. iRebal also reduces risk for you because it automates processes and minimizes key strokes that might otherwise lead to potential trading errors.
Investment Committee: More eyes to watch your investments and make us sharper
To elevate our game, we chose to invite some outside help. We formed an Investment Committee.
In the last year, we have gone from 2 eyes to 8 that are watching your investments.
The Investment Committee is your network of experts designed to enrich our capability to manage your investments. The group examines and challenges our thinking as well as making sure we practice what we preach.
Two members from the inside are Petr and myself. We also invited two outside experts. One comes with a strong academic and behavioral finance background. The other comes with decades of experience in managing large institutional portfolios.
In conclusion, I want to thank you for welcoming me as part of the Ambassador family.
Petr mentioned our plan to roll out more educational material on the new website.
We have already done 3 investment newsletters in 2018 and an interim blog. We expect to introduce additional articles and video/audio updates on different topics (not just investment-related).
Please let us know of any questions or comments. Thank you for being part of the Ambassador family.
Stuart P. Quint, CFA
Investments and Compliance
 https://www.thebalance.com/average-expense-ratios-for-mutual-funds-2466612 accessed on June 8, 2018.