“Name a financial asset - any financial asset. How did it do in 2015? The answer, in all likelihood: Meh.” – Neil Irwin, writer for the NY Times
According to Wikipedia, the word Meh is the verbal equivalent of a shrug of the shoulders. This word perhaps perfectly encapsulates the feelings most investors have toward their returns in 2015. Bloomberg ran the headline The Year Nothing Worked: Stocks, Bonds, Cash Go Nowhere. Stocks experienced volatility spikes throughout the year and finished roughly where they started. The global stock market* finished the year down around 2.4% inclusive of dividends while the U.S. stock market* posted a small total return gain of 1.4% on the year.
It isn’t unusual to see a flat or even down (remember what those look like?) year for stocks, but what was odd was the fact that most other asset classes and investments were flat to down as well. The bond market didn’t fare any better than stocks as everyone debated and anticipated the Federal Reserve’s first rate hike in close to decade. The U.S. bond market* squeaked out a total return of around a quarter of a percentage point while the global bond market* lost just over 3% for US Dollar investors.
Commodities and hard assets didn’t fare any better with the Chinese slowdown and glut in oil production out of the Middle East. Aggregate commodity prices* were off over 25% in 2015. Even real estate, as measured by publicly traded real estate investment trusts, had a flat year. U.S. REITs* were up around 2% on the year while the global REITS* finished in similar fashion up around 1%.
In addition to a variety of different asset class indexes performing poorly in 2015, active managers didn’t fair too well either. Berkshire Hathaway, run by the infamous Warren Buffett who we mentioned in last week’s post on green energy investing, was down 11.5% on the year. Stalwart hedge fund managers like Bill Ackman, David Einkorn, Joel Greenblatt and Larry Robbins fared even worse with estimated losses of 10% - 25%. Liquid alternatives/hedge funds weren’t a safe haven either. In fact, 31 funds of this type were closed during the year, the highest closure rate in the short history of the liquid alts space. Even dividend investing, which everyone has flocked to as a “bond like” alternative, stalled out in 2015. The chart below from Bespoke Investment Group shows the returns for companies in the S&P 500 broken out by dividend yield at the start of 2015. The only subset to post a gain on the year were stocks that paid no dividend.
Needless to say, there were very few places to hide in 2015. When seemingly unrelated asset classes that are driven by different risk factors start behaving in the same fashion, diversification is lost. To further unpack this statement, let us further define what we mean by different risk factors. As an example, a stock investment is exposed to a wide variety of risks ranging from macro-economic trends to sentiment shifts. A bond investor is likewise exposed to a wide variety of risks, but the types of risk such as high levels of inflation or rising interest rates are generally different than those of stocks. This is exactly why a portfolio with multiple asset classes reduces the overall risk of the portfolio by spreading our eggs (money) across multiple baskets (risks). But that diversification benefit is lost when stocks and bonds and other investments start moving together. One portfolio manager at multi-billion dollar asset manager has identified this very problem and turned to cash as one of the last, true risk reducers.
We’ve had high cash exposure relative to norm because we felt cash provides one of the only good diversifiers against the risk-off trade. – Hayes Miller, Head of Asset Allocation North America for Baring Asset Management
So why was 2015 such an odd year where seemingly uncorrelated asset classes and investment styles all struggled simultaneously? I would be remiss to say that I know the answer to this question with a high degree of certainty, but I can venture a guess. One common risk factor that all of these asset classes and investment styles have in common is central bank policy, with the most powerful player being our very own Federal Reserve. This past year was one marked change from the dovish norm since the financial crisis rocked everyone's world back in 2008. For the first time in a long time, the Federal Reserve did not expand their balance sheet, a form of monetary easing, and actually raised interest rates a quarter of a percentage point. Although nothing to write home about from an absolute perspective, Janet Yellen is no Paul Volcker, these moves represented a shift in the previous policy trend towards one that is marginally more hawkish. Investors have become accustomed to uber-dovish policy from Central Bankers around the world, so when the largest and most influential player in that space breaks rank and moves in a hawkish direction, markets tend to get rattled. Truth be told, no single risk factor can fully explain why financial assets move the way they do. By the same token, actions by an entity as influential and powerful as the US Federal Reserve can have a multitude of downstream effects on global markets. Such is the complex world we live in.
It is for this very reason that we have chosen to adopt a rather humble approach to investing which tries to mitigate risk through both diversification and a quantitative risk management system that takes gut feel out of the investment process. Some of our best investments in 2015 came from alternative allocations to peer-to-peer loans (+9%), hard money lending (+19%), and private REITs (+10%). Unfortunately, our more core allocation to MarketVANE Stocks lagged its global stocks* benchmark by a little over 4% due to the whipsaw returns we saw in the fourth quarter of last year. But it wasn’t all bad for trend following in 2015 as MarketVANE Hard Assets, which uses a very similar trend following strategy to MarketVANE Stocks, did a great job protecting capital and produced a significant amount of outperformance in the blood bath that was the commodities market* with a modest loss of less than 1%.
No style of investing is perfect, and all approaches will go through periods in which they fall out of favor (just ask value investors like Warren Buffett about this last year). It is during those frustrating times that one has to stick to their knitting and remind themselves that they are investing over a much longer time horizon than any single year of bad performance. As we tell most all of our clients, there a literally hundreds of ways to skin the cat of building a retirement nest egg. The most important thing each investor must do is figure out which style of investing best suits their emotions and personal disposition to help increase the odds of successfully making it across the finish line.
*Asset Class Indexes
US Stocks = S&P 500
Global Stocks = MSCI All Country World Index
US Bonds = Barclays Capital Aggregate Bond Index
Global Bonds = Barclays Capital Global Aggregate Bond Index
Commodities = Dow Jones UBS Commodity Index
US REITs = Dow Jones U.S. Select REIT Index
Global REITs = Dow Jones Global Select Real Estate Securities Index
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.